If you’re in the market for a mortgage, you’ve likely read about pre-qualification and pre-approval – two key steps in the mortgage-application process. While some people use these terms interchangeably, there are important differences that every homebuyer should understand. Here’s a quick look at how pre-qualification and pre-approval differ – and what to expect when shopping for a home and mortgage.
What Does Pre-qualified Mean?
Getting pre-qualified is the first step in the mortgage process. You supply a bank or lender with your overall financial picture – including your debt, income and assets – and they give you an estimate of how much you can borrow. Pre-qualification can be done over the phone or online, and there’s usually no cost involved. It’s also quick, usually taking just one to three days to get a pre-qualification letter. Keep in mind that loan pre-qualification does not include an analysis of your credit report or an in-depth look at your ability to purchase a home. It’s based solely on the information you hand over to the lender.
“Basically, pre-qualification is step one and pre-approval is step two of the mortgage process. The pre-qualification process is based on consumer-submitted data. Pre-approval is verified consumer data – for example, a credit check,” says Todd Kaderabek, a residential broker associate with Beverly-Hanks & Associates Realtors in downtown Asheville, N.C.
The initial pre-qualification step allows you to discuss any goals or needs you may have regarding your mortgage with your lender. At this point a lender can explain your various mortgage options and recommend the type that might be best suited to your situation.
Because it’s a quick procedure – and based only on the information you provide to the lender – your pre-qualified amount is not a sure thing; it’s just the amount for which you might expect to be approved. As a result, being a pre-qualified buyer doesn’t carry the same weight as being a pre-approved buyer, who has been more thoroughly investigated.
Still, being pre-qualified can be helpful when it comes time to make an offer. “A pre-qualification letter is all but required to be submitted with an offer in our market,” says Kaderabek. “Sellers are savvy and do not want to enter into a contract with a buyer who can’t perform on the contract. It’s one of the first questions we ask of a potential buyer: Have you met with a lender and determined your pre-qualification status? If not, we advise options for lenders. If so, we request and keep on file a copy of the pre-qualification letter.”
Wonder what a pre-qualification letter looks like? Here’s an example:
What Does Pre-approved Mean?
Getting pre-approved is the next step, and it tends to be much more involved. “A pre-qualification should be a good indication of credit and the ability to borrow, but a pre-approval is the definitive word,” says Kaderabek.
Of course, that doesn’t mean you should skip pre-qualification – especially if you’re on the fence about buying or unsure if you’ll be able to qualify for the type of mortgage you want. “One isn’t better than the other, and I suppose the pre-qualification step could be skipped,” says Kaderabek. “But that means a possible premature check on credit, and too many credit inquiries have a negative effect on credit.”
To get pre-approved, you’ll complete an official mortgage application and supply the lender with the necessary documentation to perform an extensive check on your financial background and current credit rating. Some lenders charge an application fee for pre-approval, which typically runs between $300 and $400. After reviewing your finances, the lender can pre-approve you for a mortgage up to a specified amount. You'll also have a better idea of the interest rate you’ll be charged on the loan, and you might be able to lock in an interest rate.
With pre-approval you’ll receive a conditional commitment in writing for an exact loan amount, allowing you to look for a home at or below that price level. Obviously, this puts you at an advantage when dealing with a potential seller, as he or she will know you’re one step closer to getting an actual mortgage.
The other advantage of completing both steps – pre-qualification and pre-approval – before you start to look for a home is that you’ll know in advance how much you can afford. This way you won’t waste time with guessing or looking at properties that are beyond your means. Getting pre-approved for a mortgage also enables you to move quickly when you find the perfect place, and in a competitive market it lets the seller know your offer is serious.
Here’s a quick rundown of how pre-qualification and pre-approval differ:
|Do I need to fill out a mortgage application?||No||Yes|
|Do I have to pay an application fee?||No||Maybe|
|Does it require a credit history check?||No||Yes|
|Is it based on a review of my finances?||No||Yes|
|Does it require an estimate of my down payment amount?||No||Yes|
|Will the lender give me an estimate for a loan amount?||Yes||No|
|Will the lender give me a specific loan amount?||No||Yes|
|Will the lender give me interest rate information?||No||Yes|
Once you’ve chosen a home and made an offer, you’ll give your lender a copy of your purchase agreement and any other documentation necessary as part of the full underwriting process, which typically takes anywhere from a few days to a few weeks. Your lender will also hire a third-party certified or licensed contractor to do a home appraisal to make sure the house you want to buy is worth the amount you’re going to spend (and borrow).
The final step in the process is what’s called a loan commitment, which is only issued by a bank when it has approved you as the borrower and the house in question. This means the home should be appraised at or above the sales price. The bank may also require more information if the appraiser brings up anything he or she feels should be investigated (for example, structural problems or a faulty HVAC system). Your income and credit profile will be checked once again to ensure that nothing has changed since the initial approval.
The Bottom Line
Pre-approved and pre-qualified are not the same thing. It’s important to note that pre-qualification is based on data you submit to a lender, who will provide a ballpark estimate of how much you can borrow. It’s not until you get pre-approved that the lender takes a close look at your financial situation and history to determine how much mortgage you can reasonably afford.
Of course, just because you are approved for that much doesn’t mean you have to shop at the top of your price range. Depending on the market, you may be able to get into a perfect house for less money than you’re approved for, leaving you extra cash each month to set aside for retirement, the kids’ college funds or to check something off your bucket list.
If you have questions about whether you should get pre-qualified or pre-approved – or both – ask your real estate agent. He or she will be able to tell you what’s typical in your market and if your letter will serve its purpose.