Today’s real estate market is highly competitive, and a potential homebuyer must be well prepared before making an offer on a home.
A home seller is unlikely to take your offer seriously unless they confirm that you have the cash to purchase or a legitimate funding source to make the purchase.
As such, preapproval and prequalification are two mortgage terms that refer to a lender's confirmation that a borrower is qualified for a loan to fund their home purchase. But, while both terms are often used interchangeably, they are two distinct processes in practice.
Let's take a closer look at what each term means and how they differ from one another. Remember, if you're in the state of Arizona (like where X2 Mortgage is headquartered), you'll have to flip the descriptions of each.
PreQualification is a preparatory step in the home buying process where a borrower learns whether he or she can get a mortgage and how much he or she can borrow.
It is a less formal process that involves going to a lender with basic financial information in order to estimate how much house you can afford and what interest rate you qualify for.
PreQualification is usually quick and easy, and most lenders do it online. At this stage, a lender simply asks you some questions about your income and assets and, based on your answers, gives you an estimate of how much you can afford to spend on a home.
Some lenders may also check your credit score to provide a more accurate estimate, but this is not usually required.
After being prequalified, you'll get a "prequalification letter", which you can show to an agent or seller as proof that you're working with a lender - not necessarily that you're well qualified, but that you have at least started the process.
A prequalification also allows you to learn about the various mortgage options available through a lender to select the best fit for your home goal.
PreApproval is a more formal stage in the home buying process in which a lender verifies a borrower's financial information and credit history.
It involves providing financial documents such as pay stubs, tax returns, and photo IDs, bank statements, etc., so that a lender can verify your income and assets to confirm your creditworthiness. With these documents, the lender can get a more accurate estimate of what you can afford.
When you are preapproved, the lender issues you a “preapproval letter” outlining your maximum loan amount and the lender's commitment to fund your home purchase if your financial situation remains unchanged.
Typically, a mortgage pre approval letter is valid for 75 to 120 days. Lenders include an expiration date on the letter because your financial situation and credit profile may change over time.
You can show the letter to your real estate agent or a home seller as proof that you can obtain a mortgage large enough to fund your home purchase. PreApprovals carry more weight with a seller because it shows you've been duly verified and can afford the home you're bidding on.
The table below compares prequalification and preapproval to show their key differences.
|Is less formal and requires only a few self-reported information.||Requires formal application and extensive documentation.|
|Does not verify the information.||Requires verification of information and documentation.|
|Estimates how much you can borrow to buy a home.||Provides conditional loan approval.|
|A lender may conduct a soft inquiry to check your credit. This does not affect your credit scores.||A lender must conduct a full a credit report, which can impact your credit scores.|
|Less reliable when making an offer on a home.||Carries more weight before home sellers and real estate agents that you can afford the purchase.|
|It can be completed within an hour.||It may take several days or weeks to be completed if your documents aren't at the ready.|
As a formal step in the mortgage process, preapproval is usually more detailed and complex. Many lenders may require several days to weeks to complete the process, but here at X2 Mortgage, we typically crank them out in 1-2 days. Our loan officers move as fast as the future homeowner will.
Understanding the preapproval process can make the home buying process easier while also allowing you to distinguish between preapproval and prequalification.
The key steps to getting preapproved are as follows:
The first step in obtaining a mortgage preapproval is completing a loan application that includes your personal information and Social Security number so the lender can grab a credit report.
A typical mortgage application is divided into sections, each requiring specific information such as;
Name, date of birth, Social Security number, marital status, education, address, number of dependents, and so on.
Employment history, name of current employer, job title, monthly income, etc.
List of banks and credit unions, the current balance in your savings account, insurance, retirement balance, stocks, and bunds. List of liabilities including car loan, student loan, children support, and other running debts.
The specific loan product you are applying for, loan amount, loan term, and interest rate.
Purchase, refinance, or construction.
The legal description of the property; primary, secondary, or investment property.
The purchase price, your plans for down payment, etc., your lender may assist in filling relevant columns.
Citizen or permanent residence, ex-convict or pending lawsuit, bankruptcy or foreclosures, etc.
In addition to your application, you will be required to provide extensive documentation about your income, savings, debt, assets, and liabilities, among other things. While every file is different, here is a list of documents typically required for preapproval:
After you submit your application, a lender must verify the information in your application and documents. Using the information you provide, a lender will evaluate your creditworthiness and determine the interest rate and the loan type you qualify for.
The lender also uses your income and account statement information to calculate your DTI and loan-to-value (LTV) ratios.
After reviewing your application and verifying your documents, the lender will make a decision that could be approved, approved with conditions, or denied.
If your application is denied, your lender will explain why and how you can improve. If you are preapproved with a condition, you may be required to provide additional documentation or improve in certain areas to satisfy the lender's condition fully. As a result, you may need to pay off some debt to lower your DTI.
Once your application is approved, a lender will usually give you a preapproval letter on official letterhead. This indicates your creditworthiness and the lender's commitment to providing funding for your home purchase.
A preapproval letter should include the loan amount, loan type, interest rate, down payment amount, the type of home you can buy, the purchase price, and the letter's expiration date. You can include this letter with your offer when bidding on a house.
If you are a first-time home buyer, prequalification is a good place to start preparing for the housing market. It allows you to estimate your purchasing budget and determine how much you can borrow. This is also a good option if you don't plan on purchasing anything in the next 6 months.
However, prequalification bears little weight when making an offer on a home and does not always result in loan approval. As a result, experts recommend getting prequalified months, if not a year, before you start looking for a home. This gives you enough time to improve your overall credit profile while saving money for a down payment and closing costs.
If you are ready to make an offer on a home, especially in a competitive market, you should bypass pre-qualification and proceed directly to preapproval.
Preapproval is more detailed and valuable. It indicates that a mortgage lender has reviewed your financial information and believes you are qualified for a loan. The lender has also made a conditional commitment to give you the home loan. A seller is more likely to consider you a serious buyer if you have a pre-approval letter.
Both pre-qualification and pre-approval are important to prepare you for the home-buying process. As a serious homebuyer, it is better to prepare well in advance by getting fully preapproved. This gives you a dialed in idea of how much house you can afford.
Plus, it allows you to pivot and make changes in case you're approved for an amount lower than your goal. Knowing all the pieces in advance, allow you to properly prepare.
However, just because you are preapproved or prequalified at this point in time, it doesn't mean you can constantly renew it if the right home doesn't come available. Renewing your approval is much easier than people think which is why professionals always recommend you start now and make changes as you go.