One of the most important steps in the home-shopping process is for buyers to have an initial assessment of their ability to get a mortgage. As a buyer, already having a mortgage preapproval letter from a lender in hand means you can move quickly when you find the home you want. As a seller, having a buyer with that letter means they are serious, and not just a “tire kicker.”
Many are confused about the two most commonly used terms: prequalified and preapproved. They are different and shouldn’t be used interchangeably. Here’s what you need to know.
With both prequalification and preapproval, the prospective home buyer contacts a mortgage lender and has a conversation about how much home the buyer can afford. The difference between the two terms lies in the depth to which the lender has taken the buyer in this initial step.
With prequalification, the conversation is an early assessment of creditworthiness. The lender asks about income, job history, debt, credit condition, and other questions. No reports or statements are pulled. From this conversation, the lender can tell buyers how much home they can afford. Nothing is guaranteed until the full mortgage approval process is completed. What is the value of this cursory conversation? It helps save time and hassle if the buyers have issues such as damaged credit. If the buyers have been self-employed, they will be on notice that they need more robust documentation later in the buying process.
The more definitive status is when a buyer is preapproved. Here, the lender drills down, getting permission to pull credit reports, receiving income verification, and looking at recent statements of bank accounts and other assets. Based on these documents, the lender can actually issue a letter of preapproval for a mortgage, up to a certain dollar amount. Most real estate agents consider this a firmer step toward buying a home.
Even with “preapproved” status, there is no final guarantee of a loan. Once a home is chosen and property is under contract, the real work of full approval begins. The lender will analyze all of the same reports with more scrutiny, send verification inquiries to employers, look at bank statements for the last several months, and examine two years of tax returns, among other things. The house will be appraised to determine the appropriate loan-to-value ratio, or the maximum percent of the home value the lender will loan. Debt-to-income ratios are then used to determine the monthly mortgage payment you qualify for based on your income, housing expenses, and recurring financial obligations. Full approval is a much more fine-tuned process.
Once pre-approved, do not change any elements of your financial profile without consulting your lender. Any of the following changes could lead to the invalidation of the pre-approval letter during the home purchase process:
- Change in employment
- Opening or closing of credit card or bank accounts
- Late payment of monthly bills or debt payments
- Purchasing a car or other large ticket items with a loan
- A deposit or withdrawal of an unusually large amount of money from bank accounts
Related – How to Score (and Keep) Good Credit