What does it mean to be prequalified or preapproved for a mortgage? The two words 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.
Here’s a look at how these two steps vary, how each can play a significant part in any home buying strategy, and how one in particular can increase the chances of having a purchase offer accepted when there are multiple offers on a house.
Getting Prequalified for a Mortgage
Getting prequalified is a relatively quick and easy process.
You, the mortgage applicant, provide a few financial details to a lender. The lender uses this unverified information, usually along with a soft credit pull, to let you know approximately how much you may be able to borrow and at what terms.
Because prequalification is an estimate of what the lender thinks you can probably afford based on the data input, the lender may ask some clarifying questions around income, assets, employment, and debt. You likely won’t be asked to provide any documentation at this point, so it’s pretty painless.
Getting prequalified can give an applicant a general idea of loan programs and the amount they may be eligible for.
But because the information provided has not been verified, there’s no guarantee that the loan or amount will be approved.
That doesn’t make this step irrelevant, though. Prequalification can help you in a few ways.
• It can give you an idea of how much house you can afford.
• It can alert you to loan programs you may be eligible for.
• It can tell you what your monthly payment might look like when you 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 prequalification 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?
Getting Preapproved for a Mortgage
Once you decide on a mortgage lender or lenders, you can begin the preapproval process.
Preapproval typically takes longer than prequalification and requires a thorough investigation of your 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 preapproval of the loan before you shop for an eligible property.
When seeking preapproval, besides filling out an application, you may be asked to submit the following to a lender for verification:
• Social Security number or some other form of identification
• Two most recent pay stubs
• W-2 statements for the past two years
• Tax returns from the past two years
• Sixty days’ worth of documentation (or a quarterly statement) of the activity in checking, savings, and investment accounts
• Residential addresses from the past two years, including contact information for rental companies or landlords, if applicable
The lender may require backup documentation for certain types of income in order to qualify for a mortgage. For example, rental property owners may be asked to show lease agreements. Freelancers may be asked to provide 1099 forms, bank statements, a profit and loss statement, a client list, or work contracts.
Buyers also can expect to have to explain negative information that might show up during a credit check. (To avoid any surprises, proactive buyers can get annual free credit reports from freeannualcreditreport.com. A credit 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. Applicants face a waiting period, which varies with the lender and whether they are seeking a conventional vs. government home loan, after a bankruptcy dismissal or discharge and before being eligible for new loan approval.
The lender will need to verify the amount and source of the down payment you plan to provide. If your parents are kicking in some cash, for example, the lender will ask for a gift letter that confirms that the money is a gift and not a loan. Some loan programs may require you to contribute a certain amount of your own money (sometimes 5%) to the loan before a 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.
Three Reasons to Get Preapproved
Sounds like a lot of work, right? But preapproval has at least three selling points:
1. Preapproval lets you know the specific amount you are qualified to borrow from the lender, instead of just an estimate. You can always purchase a house for less than the preapproved amount.
2. Going through preapproval before house hunting could take some stress out of the loan process by breaking up the borrower and property underwriting portions of the loan. Underwriting, the final say on mortgage approval or disapproval, comes after you’ve been preapproved, found a house you love and agreed on a price, and applied for the home loan.
3. Being preapproved for a loan helps to show sellers that you’re a vetted buyer. The lender can provide a preapproval letter that indicates the willingness to lend you a particular amount, and the interest rate and fees you can expect to pay on that loan (though it’s not a guarantee that you’ll get the loan).
Depending on the real estate market, sellers might receive offers from multiple buyers. Having a preapproval letter could improve the chances that your offer will be selected, especially if other offers lack a preapproval letter.
The letter tells the seller that your credit, income, and assets have been reviewed and approved by a lender to move forward and that if the property is eligible, the loan should close with no issues to derail the purchase.
Time Is of the Essence
A preapproval letter usually expires in 90 days because pay stubs, bank statements, and so on are considered dated after 90 days.
If the information needs to be updated and reverified after that point, the preapproval letter can be reissued with a new expiration date.
If you’re seeking loan preapproval, you may benefit from mortgage rate shopping within a focused period—generally 14 to 45 days, varying by the credit score model each lender uses—to avoid dragging down your credit score.
If you apply for mortgages with several lenders within the condensed time frame, and each makes a hard pull of your credit, it will count as just one hard inquiry.
Finalizing the Mortgage Application
After you find the house you want to purchase and the seller has accepted the offer, the next step is to finalize your mortgage application and move toward final loan approval.
You don’t have to choose a mortgage from the same place a preapproval letter came from.
Once the lender receives the property appraisal and title report, 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.
The lender may perform another credit check right before a loan closes. Applying for any new credit cards or 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.
It’s a good idea to verify the time period to make sure the rate is in effect through the escrow closing date, and to 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 you pass the loan approval process with flying colors, the home being purchased might not. The lender will likely order an appraisal to be sure the selling price is accurate and that the property type (single-family home, farm, etc.) and condition are eligible for home loan financing.
If the sales price is higher than the appraised value, you may have to go back to the negotiating table, walk away from the deal, or come up with cash to make up the difference.
What If My Preapproval Didn’t Pan Out?
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 stop to home buying hopes.
If you are in that boat, you might want to try to understand why you were not eligible.
• Consider another loan product or lender where you might meet the lending criteria.
• Work on improving whatever put a damper on your home loan qualification.
• Find a home that’s better suited to your budget if you were preapproved for a lower loan amount than expected.
Preapproval vs. prequalification: If you’re serious about buying a house, do you know the difference? Getting prequalified and then preapproved may increase the odds that your house hunt will lead to homeownership.
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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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