Buying a home can be an exciting and nerve-wracking time, especially for first-time homebuyers. There are many steps to understand and manage in the home-buying process, and it’s likely a lot less stressful when you work with a trusted lender.
Many hopeful homebuyers believe the process begins with finding the perfect house, but diving directly into a home search skips two important steps that could end up putting buyers at a disadvantage.
Before starting to house hunt, it can be helpful get an understanding of how much home you can afford and then to contact a mortgage lender to discuss getting pre-qualified and pre-approved for a mortgage loan.
What does it mean to be pre-qualified and/or pre-approved for a mortgage? The two terms are often used interchangeably, but they aren’t the same thing and don’t carry the same weight when a hopeful homeowner is ready to buy.
Below is a look at how these two steps vary, how each can play a significant part in any home-buying strategy, and how they can help increase the chances of getting a home purchase offer accepted.
The Pre-qualification Process
Getting pre-qualified is a relatively quick and easy process in which mortgage applicants provide a few financial details to a lender, and the lender uses this unverified information, usually along with a soft credit pull, to let the applicants know approximately how much they may be able to borrow and at what terms.
Because pre-qualification is an estimate of what the lender thinks the applicant can probably afford based on their data input, lenders may ask some clarifying questions around income, assets, employment, and debt. Buyers likely won’t be asked to provide any paperwork that proves the information they stated is accurate at this point, so it’s pretty painless.
A pre-qualification can give an applicant a general idea of what loan programs and loan amounts they may be eligible for, but because the information provided is not verified as true and correct, this also means there’s no guarantee the mortgage loan program or amount shown at this stage will actually be approved in the future, when a hard credit pull and verification of information are completed. Not all income sources are eligible to be used for home loan qualifying.
That doesn’t make this step irrelevant, though. Pre-qualification can help buyers in a few ways. It can give them an idea of how much house they likely can afford, what loan programs they may be eligible for, and what their potential monthly payment might look like when they do get approved for a mortgage.
It might be tempting to blow through this step by providing incomplete or embellished financial information to lenders—or to skip the pre-qualification process entirely. But who wants to fall in love with a house they can’t potentially afford? And who wouldn’t want to weed out any mortgage programs or lenders that don’t suit their needs?
The Pre-approval Process
Once buyers decide on a mortgage lender or lenders, they can begin the pre-approval process. Pre-approval typically takes longer and requires a much more in-depth exchange of information than pre-qualification. The process is more formal, and at this point, lenders will do a thorough investigation of the buyer or buyers’ income sources, employment history, assets, credit history, and other financial commitments and debts.
Verification of this information, along with a hard credit pull from all three credit bureaus, allows the lender to complete a full approval of the borrower side of the loan before the borrower goes house shopping for an eligible property. Going through the pre-approval process prior to house shopping could possibly take some stress out of the loan process by breaking up the borrower and property underwriting portions of the loan. This can help the borrower focus on one aspect of the loan approval process at a time.
While a pre-qualification is usually based on self-reported and often unverified information, a pre-approval is not. Besides filling out an application, buyers may be asked to submit the following to a lender for verification:
• Social Security number(s), birthdate(s), some other form of identification
• Pay stubs for the past 30 days
• W2 statements for the past two years (this is the Wage and Tax Statement employers send to employees and the IRS at the end of the year)
• Federal tax returns from the past two years
• 60 days’ worth of documentation (or a quarterly statement) of the activity in any asset accounts, including checking, savings, and investment accounts
• Residential addresses from the past two years, including contact information for rental companies or landlords if applicable
The lender also may require backup documentation for certain types of income. For example, those who own rental properties may be asked to show lease agreements. And freelancers may be asked to provide things like 1099’s, a profit and loss statement, a client list or work contracts.
Buyers also can expect to provide an explanation about negative information that might show up during a credit check. (To avoid any surprises or problems, proactive buyers can get an annual free credit report from freeannualcreditreport.com . This free annual report shows all balances, payments, and derogatory information but does not give credit scores. It may help potential borrowers identify and amend errors before applying for a loan.)
Those who have filed for bankruptcy in the past may have to show documentation that it has been discharged. It’s good to note that there are waiting periods and other guidelines that may need to be followed depending on the loan product and lender after a discharged bankruptcy and before you are eligible for new loan approval.
The lender will need to verify things like the amount and sources of the down payment the buyer plans to provide. If a borrower’s parents are kicking in some cash, for example, the lender will ask for a gift letter that confirms the money is a gift and not a loan, along with other supporting documentation.
Some loan programs may require that the borrower contribute a certain amount of their own money (sometimes 5%); into the loan before an outside gift can be applied. Generally, investment properties are not eligible for gift funds.
Those taking a loan or withdrawal from a 401(k) also typically will have to show the paperwork. And any sudden changes in finances may have to be explained—so it’s important to have a paper trail.
Sounds like a lot of work, right? Pre-approval lets buyers know the specific amount they are qualified to borrow from the lender, instead of just an estimate. Buyers can purchase a house for less than the approved amount—and, based on their personal budget and goals, they may want to set their own limit before they start their home search. But getting pre-approved for a larger loan can provide greater flexibility.
What can make the pre-approval process especially valuable is that it helps show sellers that buyers are serious because they are pre-approved to obtain the financing they’ll need. The lender can provide a pre-approval letter showing that an applicant has been pre-approved for a certain type of mortgage loan and a specific loan amount.
Depending on the real estate market, sellers might receive offers from multiple buyers. Having a pre-approval letter could help improve the chances that a buyer’s offer will be selected, especially if other offers are lacking a pre-approval letter.
A pre-approval letter usually expires in 90 days because of a general lending policy that the borrowers pay stubs, bank statements, etc., are considered too dated after 90 days and needs to be updated and re-verified. Then the pre-approval letter can be re-issued with a new expiration date. Buyers who run out of time might be expected to provide updated info if they want to keep looking. The expiration date typically appears on the pre-approval letter.
As with pre-qualification, a buyer isn’t required to have pre-approval to begin shopping for a home. Many real estate professionals might agree to show properties and submit offers without a pre-approval letter.
But serious buyers could benefit from knowing just how much they’re qualified to borrow and from showing sellers that their credit, income, and assets have been reviewed and approved by a lender to move forward. This letter tells the seller that certain borrower criteria are reviewed and approved and that if the property is eligible, the loan should close with no borrower issues (credit, income, downpayment) coming up as a surprise to derail the purchase.
After all, the sellers might have a timeline of their own. They might be relocating for a job. They might want to downsize for retirement. And they could already have a purchase in the works that’s contingent on selling their current home.
Borrowers seeking pre-approval may benefit from doing their mortgage rate shopping within a focused period, such as within 30 days. According to the myFICO website, “Looking for new credit can equate with higher risk, but most credit scores are not affected by multiple inquiries from rate shopping for things like auto, mortgage, or student loan lenders within a short period of time.”
Typically, these “rate shopper inquiries” are treated as a single inquiry and will have little impact on your credit scores. Scores distinguish between a search for a single loan and a search for many new credit lines, in part by the length of time over which the inquiries occur.”
Finalizing the Mortgage Application
After a buyer finds the house they would like to purchase and the seller has accepted the offer, the next step is to finalize the mortgage application and move toward final loan approval. A borrower doesn’t have to choose a mortgage from the same place they received the pre-approval letter and could shop around for the best loan program and rate.
Once the remaining elements are received by the lender, such as the property appraisal, title report, and any inspections needed, a loan underwriter reviews the data and issues a loan commitment letter or final approval. This means that the loan has been fully approved and a closing date can be scheduled.
Buyers might want to keep in mind that even though borrowers may be pre-approved, lenders may perform another credit check right before a loan closes.
Changes to a buyer’s financial situation before loan closing could impact a loan approval. Applying for any new credit cards, auto loans, or making large credit purchases during the home-buying process could affect final mortgage approval.
Some borrowers choose to “lock in” the interest rate offered by the lender once they find a home they want to buy. This freezes the mortgage rate for a predetermined period, so the borrower doesn’t have to worry if rates rise between their accepted offer and when they actually close on the home.
It might be expensive to extend a rate lock, so one good idea would be to verify the time period to make sure it’s in effect through the escrow closing date. Review the fully executed purchase contract with the lender for closing and loan contingency timelines to be sure contract dates can be met.
Finally, even if a buyer passes the loan approval process with flying colors, the home being purchased might not. The lender will likely order an appraisal or other home valuation to be sure the selling price is accurate and that the property type (single family home, farm, etc.) or condition (dry rot, termites, etc.) are eligible for home loan financing.
The sales price might be lower than the appraised value, but if it’s higher, buyers may have to go back to the negotiating table, walk away from the deal, or come up with more cash themselves to make up the difference.
What If Buyers Don’t Qualify for Pre-approval?
Being turned down for a mortgage—or not being able to borrow as much as expected—can be disappointing. But it doesn’t have to put a complete stop to any home-buying hopes. A potential borrower might want to try to understand why they were not eligible.
Is there another loan product or lender where they might meet the lending criteria? If not, there may ways to improve certain factors that lenders look at when they’re considering who meets the lending guidelines of any given loan program.
Depending on the reasons a potential borrower isn’t meeting their chosen lenders guidelines, borrowers could possibly work on improving certain aspects that can affect home loan qualification. Borrowers might be pre-approved for a lower loan amount than expected, requiring them to downsize their expectations and find a home that’s better suited to their budget.
Which takes us back to why it might be a good idea to involve a mortgage lender at the start of the home search process. The last thing a borrower wants is to find the perfect house only to discover that they either don’t qualify for a mortgage loan or that the seller accepted another offer because they were pre-approved.
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Checking Your Rates: To check the rates and terms you may qualify for, SoFi conducts a soft credit pull that will not affect your credit score. A hard credit pull, which may impact your credit score, is required if you apply for a SoFi product after being pre-qualified.
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