On the path to owning your home, you would most likely come to a crossroads between two choices - prequalification or preapproval.
At the most basic level, both are types of mortgage approvals, and they refer to the steps a lender takes to verify that a client can afford a mortgage.
Both ways are meant to help give home buyers a realistic idea of how much they can afford when shopping for a home, but they do take place at different steps of the home buying process.
While some use these terms interchangeably, which can make it difficult when trying to understand the important differences between them. In both cases, a lender reviews a home buyer's financials and estimates how much mortgage they can afford.
The major differences lie in how the estimate is obtained and considered by the lender.
As you begin searching for a home, real estate agents and sellers want to see you’ve been working with a mortgage lender so they know you can afford to buy a home. If you are a prospective home buyer, it is essential to understand what these terms mean – they’ll guide your home search and help you focus on homes you can afford.
This article gets to the nitty-gritty of both types of mortgage approval and how you can use this knowledge to make the strongest offer possible on the property of your choice.
A prequalification is when a mortgage lender gathers some basic financial information from you in order to determine the amount of house you can afford. When you get confirmation from a lender that you're pre-qualified for a house loan, you'll have a good estimate of how much you'll be approved for at closing.
Prequalification is simple and inexpensive, if not completely free. It can generally be done over the phone or online, and the entire process takes less than a day. You provide your bank or lender with some basic financial information, either verbally or in writing, and they give you an estimate of how much you can probably borrow.
When you are prequalified for a mortgage, you usually get a ballpark figure. This is due to the fact that the financial information provided is self-reported and cannot be validated by obtaining your credit report or analyzing your financial records.
As a result, the accuracy of your prequalification estimate is totally reliant on the information you provide to your lender. In most cases, you'll be requested to disclose information about your income, assets, and debt. If a lender wants to be thorough, they'll ask for your credit score because it tells them what kinds of loans you might be eligible for. Most lenders, however, do not require a credit score at this stage because it is only a preliminary estimate.
The debt-to-income ratio (DTI) is computed by dividing your loans by your income. This allows lenders to figure out how much of a monthly payment you can afford, allowing them to establish the maximum house price you're eligible for. You'll normally receive a "prequalification letter" after you've been prequalified, which you may show to an agent or seller as confirmation that you're working with a lender.
Pre-approval
Prequalification is a good beginning step, but it doesn't have the same weight as a pre-approval because the lender hasn't confirmed your financial information.
A mortgage pre-approval is a more formal step that needs your financial information and credit history to be verified by the lender. Pay stubs, tax returns, and even your social security card may be necessary for a preapproval.
The borrower must submit an official mortgage application to the lender, as well as all required papers, in order for the lender to conduct a thorough credit and financial background check. The lender will then give you a pre-approval for a certain amount.
When you present a preapproval letter to a seller, it shows that your financial information has been validated and that you can afford a mortgage. It is a more reliable indicator of your ability to pay and lends more credibility to your offer than a prequalification.
Pre-approval also gives you a better understanding of the interest rate you'll be paying. Some lenders enable applicants to lock in an interest rate or charge a pre-approval application fee, which can go into the hundreds of dollars.
Lenders will offer borrowers a written conditional commitment for a certain loan amount, allowing them to seek for properties at or below that price point. When engaging with a seller, this gives borrowers an edge because they're one step closer to receiving a mortgage.
Preapproval and prequalification are both hints from a mortgage lender that you are qualified for a loan, but a preapproval is more precise – and more of a promise. Because prequalification does not necessarily imply loan approval, homeowners should not make any definite decisions solely on their qualifying status.
Prequalification is the yellow traffic light, and preapproval is the green light if the mortgage loan procedure were a highway crossing. In today's housing market, that green light is critical. Because certain markets are very hot, sellers may face many bids. If they have to choose between an offer without a preapproval letter and one with one, they'll probably opt with the pre-approved buyer since it's a safer bet.
While there are some distinctions between preapproval and prequalification, both include credit checks. If they're done within a short period, generally 45 days, they'll be listed as one query on your credit report. This also means prequalification is less reliable than a preapproval, which usually involves your lender checking your credit score and reviewing bank statements and other documents.
Take a look at your budget to see how much you can give to a down payment before asking a mortgage lender to pre-approve you for a particular amount of money. To calculate your loan-to-value (LTV) ratio, most lenders will need a notion of what you expect to cover. Also, assemble all of the documents that will be needed so that you are prepared to pass them off.
Remember that just because you've been preapproved or prequalified by one lender doesn't imply you'll have to receive your mortgage from them. Because rates and conditions differ, it's always a good idea to browse around before deciding on a loan. You can find out if you're receiving the greatest bargain by shopping around with several lenders.
Mortgage approvals are handled differently by each lender. The processes and language used differ from one lender to the next. Many lenders use the terms prequalification and preapproval interchangeably, despite the fact that they used to represent fundamentally different things.
Any form of mortgage approval isn't a guarantee that you'll be able to finalize the deal. Prequalification, also known as pre-approval, is a process through which a lender assists you and a seller in determining how much you can pay. After you've found a property and made an offer, you'll need to have it appraised by a third party and examined for possible repairs before you can complete the loan and purchase it.
A mortgage prequalification is a good way to get an estimate of how much home you can afford. Which is good when you want to plan towards home-ownership. It allows you to have an estimate of your dream house, including the financial requirements to owning one.
However, when you are serious about making an offer, a preapproval is the best way to show sellers that you can afford a home because your financial information has been verified. So it ultimately depends on which stage of the home ownership process you are in.
Photo by Florian Schmidinger on Unsplash
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