Pre-Approval vs Pre-Qualified Mortgage

by | Feb 19, 2018

How do you go about knowing which type of loan is going to be the best for your situation? The answer is simple, getting pre-approved for a mortgage! There are many buyers out there who don’t understand why it’s important to get a pre-approval. In fact, many of them believe they don’t need a mortgage pre-approval before looking at homes. This is wrong and quite frankly, is one of the top things that buyers do that real estate agents hate.

When and why should you have a pre-approval for a mortgage? Below is a detailed explanation not only on when you should obtain a mortgage pre-approval but also many reasons why it’s extremely important to have one in hand before buying a home.

Pre-Approval Versus Pre-Qualification:

There are some people that believe a pre-approval and a pre-qualification are the same and also some lenders who use the two interchangeably, they are not. They are actually very different and it’s important to understand what the differences are when buying a home.

What is a Pre-Approval?

A mortgage pre-approval is when a lender gives their written commitment to a potential borrower. The mortgage pre-approval process is one in which a lender will obtain from the potential borrower their bank statements, tax returns for the past several years, verify their employment, and pull a tri-merge credit report. This process does not have to take a substantial amount of time, however, does take a little more time than a pre-qualification, however, the extra time is time well spent.

It’s important to understand once a mortgage pre-approval is issued, there are still a handful of conditions that must be met before the lender is going to release the funds. The most common condition in a mortgage pre-approval is that the buyer finds a property and a satisfactory appraisal is done on the property. This means the subject property must be worth what the buyer and seller agree to and also there are no bank required repairs. Other possible conditions in a mortgage pre-approval can include an acceptable homeowner insurance binder, continued creditworthiness, and in some cases, depending on the financing, proof of an acceptable home inspection.

What is a Pre-Qualification?

A mortgage pre-qualification can be best described as a prediction on the amount a buyer can borrow. In many cases, a pre-qualification is only as good as the piece of paper it is written on. Many lenders will ask a potential borrower about their incomes, debts, and other assets and use what they are told to issue a pre-qualification. Some lenders will pull a credit report but some will not. This often can lead to surprises in the future once a buyer goes to formally apply for their mortgage.

The answer to when you should get pre-approved for mortgage is simple, before you begin looking at houses. As mentioned above, many buyers don’t understand why this is important. Below are several reasons you will be glad you obtained a pre-approval for a mortgage before looking a houses!

Eliminate Disappointment

No one likes to be disappointed or a disappointment. The same goes for someone who is purchasing a home. Another very important reason why a pre-approval should be obtained before looking at homes is because it can eliminate disappointment. Unfortunately there are many real estate agents who show houses to a buyer even though they or the buyer, have no clue whether they can afford a home or not. This is a disservice to a buyer more than anybody else.

Why is this a disservice to a buyer? The fact of the matter is, a buyer can “fall in love” with a home, submit a purchase offer, and find out once they speak with a mortgage lender that they cannot obtain that home due to credit problems or because of other reasons. This understandably can leave a buyer upset, heartbroken, and disappointed! This can all be avoided by having a mortgage pre-approval before looking at homes.

Understand All Of The Costs To Buying A Home

There are many costs associated with buying a home. It’s not as simple as a 3% down payment on a home. By getting a pre-approval, you will have a very strong understanding what costs you should expect when buying a home, so there are no surprises. The first thing you will learn when buying a home, is that everybody has to get a “piece of the pie.” Typically when buying a home, you have to pay a full years real estate tax, an entire years homeowners insurance, and many miscellaneous costs.

Bottom line, get pre-approved so you have a full understanding how much money you will need to close on your dream home, who you will be paying these costs too, and also why you are paying these costs.

Self Employed Or Commission Based Buyers

If you are self employed or are considered an independent contractor, getting a pre-approval is extremely important to do before looking at homes. There are many rules that apply to those who are self employed versus those who are an employee of a company. Several years back, there were lenders who allowed self employed purchasers to obtain a “no-doc” or no-documentation loan, which allowed a buyer the opportunity to purchase a home without providing all the necessary documentation that is required by lenders now-a-days. The days of “no-doc” loans are gone. If you are a self employed buyer, you will need to provide at the very least, 2 years tax returns.

Does your income heavily rely on commission? If so, like a self-employed buyer, there are different requirements that a lender will have. Often lenders will require 2-3 years proven history showing the commission amounts earned is fairly consistent. Normally a lender will take the 2-3 years history and average them out. For example, if a buyer has a sales position and they have a three year commission history of $100,000, $200,000 and $150,000, the will likely use an average expected commission income of $150,000 or less. A lender wants to be comfortable that the commission income is obtainable, year after year, before approving the loan.

The main reason a quicker closing can happen is because the majority of the background checking has been completed by the lender prior to obtaining an accepted offer on a property. Once a pre-approved buyer is under contract and any inspections are completed, the lender can order the appraisal on the property. As a pre-approved buyer, you will have already filled out the mortgage application, given the past few years tax returns, and your credit has been reviewed with a “fine-toothed comb.”

As you can see, there are many reasons why having a mortgage pre-approval is important and why it should be done before you look at homes. A great real estate agent should give many of the same above reasons why getting a pre-approval will be beneficial in the long run! Don’t make the mistake that many buyers do, which is not getting their pre-approval in order before looking at homes.