Posted December 28, 2007 - Jeffrey Noe
"We are seriously considering buying a home in the next 6 months. Should I get pre-approved or pre-qualified for a loan beforehand? Why? Is it necessary? What's the difference?" Understanding the answers to each of these questions is an important key to a successful, stress-free home buying experience. First of all, a pre-qualification is not the same as pre-approval. In any real estate transaction, the buyer, seller, and agents involved in should be in agreement regarding the buyer’s ability to bring the home purchase to a successful close. If you haven't done so already, your Realtor will want you to talk with a mortgage company as soon as possible. The Realtor needs to know the top price range you can afford as well as the housing expense that you are comfortable with. In addition, it significantly helps your Realtor from a negotiating standpoint when presenting an offer to the seller’s agent to show that you have taken the necessary steps for your mortgage approval. Not only can it help to persuade the seller to accept your offer, it strengthens your position in the negotiation. It can greatly speed-up the closing process by, essentially, eliminating a step after the offer is accepted and can eliminate a "contingency" with your offer (i.e. pending mortgage approval). In many markets, and specific real estate transactions, a pre-qualification or pre-approval letter is required as part of the purchase documents to the sellers and their agent agent.
Let's begin with pre-qualification. Getting pre-qualified for a mortgage helps give you an idea as to how much you might be able to borrow. When you speak with a mortgage lender to be pre-qualified, you are essentially providing information about your financial condition. But since you did not actually apply for a loan and the lender only has your word on your credit, assest, liabilities, and income, the mortgage loan is not guaranteed simply because no information has been formally verified. The lender will ask questions regarding your credit. There may be a credit bureau check to see where you stand in terms of your credit score. The lender will provide you with an opinion of what you can afford based solely on the information that you have provided. It is important to understand that this is not a commitment to actually make the loan. The mortgage company should provide you with a letter outlining the pre-qualified mortgage amount as well as the type of loan. It should clearly state that loan approval could likely be issued after the information you provided is verified and formally underwritten. The term means that someone has taken a general look at your income and expenses and plugged them in to a debt-to-income ratio formula. Pre-qualifying yourself before you start looking for a home gives you nothing more than a general idea of the price range you can afford. A mortgage pre-approval has significantly more weight than a pre-qualification.
A pre-approval letter will give the maximum loan amount with the specifics of the type of mortgage loan that you qualify for. The pre-approval letter should only state conditional terms such as a clear title report, underwritten appraisal, general closing conditions, and no negative change in your status as a buyer. It can discuss the interest rates it will offer for different types of loans. A pre-approval is a much firmer commitment on behalf of the mortgage company and is a more formal process which includes a credit check and even an employment verification. During the pre-approval process, the mortgage company does almost all the work of a full approval, except for the appraisal and title search. The lender will obtain a copy of your credit report to verify your monthly payments on installment loans and credit cards and to check whether you have a history of making your payments on time. You will need to provide paystubs and W-2 forms (or tax returns if you are self-employed), plus statements from savings and investment accounts to verify your assets. If you've been pre-approved for a loan, you can shop for a house with more certainty about your buying power and less anxiety because you won't be going through the whole process worrying about your mortgage approval. However, it still isn't a guarantee that the lender will ultimately approve the loan. At a minimum, if you are serious about buying a home and satisfied with the mortgage company, you should always get a pre-approval. Neither you, your Realtor, the Seller, or their agent wants to have any surprises along the way.
A loan commitment is issued by a lender after it has approved both the home and you. A home appraisal must meet the lender's guidelines, which usually includes a stipulation that the home must appraise at or higher than the sales price. Price is just one aspect of the home the bank considers. An FHA appraisal is even more detailed than those required for conventional loans. Every area has its own issues. Your Realtor should be able to advise you about potential red flags or problems that could affect your purchase. In addition, a title search must show that the home's title is cloud-free, meaning there are no problems associated with it such as outstanding liens that can't be paid at closing, pending lawsuits, right-of-way issues, etc. Your credit report could be checked again prior to closing in order to make sure it hasn't negatively changed. You'll be asked to show proof that the home will be insured as soon as ownership transfers to you. The loan commitment letter is issued only when the bank is sure it will lend. Therefore, if you must provide a loan commitment date on your offer to purchase, be sure it provides plenty of time for the lending institution's requirements. If a commitment date is a part of your contract, the seller can request to see written proof that your lender has issued it as soon as the date has passed.