Pre-qualified Vs. Pre-Approved

If you’re gearing up to buy a home you might be confused by some of the mortgage terminology you encounter, such as pre-qualified or pre-approved. You have a vague idea that at some point in your journey, you’re probably going to need at least one of them. But what exactly are they? What’s the difference between them? And is one stronger than the other? 

Let’s lay it all out.

What Is A Pre-Qualification?

A mortgage pre-qualification is an estimate of your ability to borrow money. It’s a shortcut for lenders and buyers to assess whether your mortgage will be approved. The five questions in a first time home buyers pre-qualification:

1. Where do you live now and what is your rent?

2. What is your annual household income?

3. What is your credit rating?

4. Have you had a recent bankruptcy?

5. Do you plan on making a downpayment?

Homebuyers can answer the pre-qualification questions with the truth, lies, or a version that’s in-between. A lender will not verify the information provided, nor ask for proof.

Pre-qualifications are unverified estimates of a person’s home buying power.

The advantages of getting pre-qualified to buy a home is that it’s quick. The disadvantage is that a pre-qualification is inaccurate, unhelpful, and can sometimes set poor expectations, especially for first time home buyers.

What Is A Mortgage Pre-Approval?

A mortgage pre-approval verifies that a buyer can purchase and finance a home. Pre-approvals are reliable. They consider a buyer’s credit, income, and assets, and use that information to conditionally approve a mortgage.

Six verifications comprise a mortgage pre-approval:

1. Verification of name, address, and phone number

2. Verification of credit score and credit history

3. Verification of income and employment history

4. Verification of assets and savings

5. Verification of citizenship and eligibility

6. Verification of debts and remaining loan payments

In addition for VA loans, lenders will verify VA eligibility and for USDA mortgages they’ll verify USDA eligibility.

Mortgage pre-approvals use hard credit inquiries (will show on your credit report) and when digital data is unavailable lenders verify with W-2s, pay stubs, tax returns, and personal bank statements.

Pre-approvals are dress rehearsals for a final mortgage approval. When your mortgage is pre-approved, you know exactly how much home you can afford to buy and for what mortgage rate you’re expected to qualify. You also get a verified estimate of your mortgage closing costs and a projection of your monthly payment.

Lastly, pre-approved home buyers receive a pre-approval letter, sometimes called a Verified Approval Letter. A Verified Approval Letter tells homesellers that you, as the buyer, can purchase and finance their home. Home sellers rarely accept offers without a Verified Approval Letter.

What’s The Difference: Pre-Approval Vs. Pre-Qualification

In the simplest of terms, pre-approved buyers have already been approved for the loan. The lender has analyzed their credit, debt to income ratio, timely payments on existing loans, and ultimately has already determined that they can uphold a mortgage.

Pre-qualified buyers are still in the very early stages of purchasing a home. They have an idea of how much money they can spend, but they haven’t gone through the necessary steps to secure their loan. Once a pre-qualified buyer completes the pre-approval process, they may find that the mortgage they’re eligible for is actually much smaller than they initially thought.

Pre-Approval

• Verifies a home buyer’s income using government mortgage standards, including depreciation add backs and government multipliers

• Verifies the homebuyer’s assets and savings using government mortgage standards

• Performs a credit review to find revolving and long-term debt

• Verifies a 2-year history of housing payment to calculate for payment shock and other anomalies

Pre-Qualification

• Uses the home buyer’s estimate of their annual income

• Uses the home buyer’s estimates of their assets and savings

• Uses the home buyer’s estimates of their monthly bills and obligations

• Does not account for payment shock and other potential mortgage disqualifiers

Pre-approvals do four things that pre-qualifications do not:

1. Pre-approvals affirm that a buyer can get financing on a home

2. Pre-approvals set a buyer’s maximum purchase price

3. Pre-approvals keep a buyer within their budget

4. Pre-approvals strengthen a buyer’s offer to a seller

What Do You Need For Pre-Approval?

If you’re ready to get pre-approved, then it’s time to start pulling together your mortgage loan paperwork. This process is more involved than a pre-qualification because the lender will be committing to providing you with a mortgage. Your lender isn’t making that commitment with a pre-qualification.

To get pre-approved be prepare to produce the following information:

• Social Security Number – In most cases you may only need to know your social security number. In others, however, a lender may ask for your physical card.

• Drivers License, Passport, or other state issued ID – A lender will need to verify that you are who you say you are

• Proof of Employment and Proof of Income – Plan on showing documentation of two or three years of employment and income history. This applies to self-employed people as well.

• Tax Documents – A lender will want a picture of your overall financial situation and may request tax documentation from the last few years.

• Proof Of Residence – Previous addresses may be necessary for mortgage seekers with fewer than three years or so at a current address.

• Bank Statements – This includes, checking, savings, money markets and other bank statements.

• Proof of Other Assets – If you have other investment accounts (stocks, IRA’s, mutual funds, etc.) you have to share documentation of their value. To a lender these are considered liquid assets.

• Real Estate – Your lender will be interested in any other mortgages you are paying. They’ll want to know if you have property you own outright or that’s no longer mortgaged. If you’re a rental property owner, the income will be provided in your income statement, and the property has value on its own.

• Credit Information – This is where your credit report comes into play. Typically, your lender will pull your credit report and you won’t have to provide the information directly. You will, however, have to sign paperwork allowing them to get this data. Credit reports that reflect high credit card debt, missed payments, defaulted accounts, and numerous hard inquiries or mortgage applications made recently may face challenges trying to secure the best offers.

• Debts – Your credit report will include most of your debts, but there may be a few that aren’t listed, so you want to provide any debt related information not present on your report.

• Monthly Expenses – Not every lender requires monthly expense information. But even if it isn’t required, these are great details to have when planning your new budget. Many banks provide snapshots of monthly expenses, so be sure if your bank has one to use it for the most accurate information.

Because every person’s financial situation is unique, and each lender has a slightly different process, you may have to provide some additional paperwork. This list will at least give you a solid idea of where to start focusing your efforts.

Which Should I Choose: Pre-Qualification Or Pre-Approval?

The right choice ultimately depends on what you need and what your timeframe is. Here are some examples of when you might want to get pre-approved or pre-qualified:

• Looking for a quick and general estimate on what you can spend on a home? Try getting pre-qualified.

• Are you serious about purchasing your dream property on a quick timeline? Opt for pre-approval.

• If your financial and personal documents are already organized, go ahead and get pre-approved.

• If you expect to enter the traditional real estate market, which is extremely competitive, set yourself up for success with a pre-approval.

Why A Strong Pre-Approval Gives You An Advantage

Sellers are always looking to select the strongest offer possible. No seller wants to go through the frustration of accepting an offer and then have the deal fall through because the buyer can’t secure proper financing. This is why so many home sellers favor cash: it’s a sure thing.

Say a home seller is assessing three offers. Two of the offers are from buyers with pre-qualification letters, and one buyer has gone through the pre-approval process. It is almost certain that the seller will choose the pre-approved buyer (maybe even at a lower price) because they’ve already had their financials assessed. This takes an unknown out of the equation and gives the seller more certainty in closing the deal.