Pre-Qual vs Pre-Approval: Why Pre-Approval is Better
You think you know how much home you can afford, but do banks agree?
That’s the problem.
Oftentimes we think we can afford more than loan programs allow. But, there’s an easy way to find out. Before you look at homes, get pre-approved.
Notice, we didn’t say pre-qualified? Buyers often confuse the two terms, but one holds more weight than the other.
What is Pre-Qualification?
A pre-qual is an estimate of what you can afford. Nothing is binding about it. It’s a verbal conversation with a loan officer. You tell him/her the following information and they match you with a program:
- Estimated credit score (some lenders may pull your credit)
- Average monthly income (before taxes)
- Assets on hand for a down payment and closing costs
- Employment information
With this information, lenders determine which program you might qualify for, such as conventional, FHA, or VA loans.
You’ll also learn an approximate loan amount you may qualify for – remember, this isn’t binding. They use the information you provided to determine an approximate loan amount.
When Should you use a Pre-Qualification?
There are times when a pre-qual is enough. For example, if you aren’t sure if you’re ready to buy a home, it’s a great starting point. You’ll learn how much loan you can afford (according to a lender). You’ll also get a fee for the payment amount.
If it’s your first home, work the payment around in your budget. How does it feel? No matter what a lender says you can afford, you have to feel comfortable with the payment.
Don’t forget on top of the principal and interest (and potentially mortgage insurance), you’ll pay real estate taxes and insurance. Home maintenance is another factor. Estimate 1 percent of your home’s value in annual maintenance costs.
What is a Pre-Approval?
A pre-approval takes the pre-qual one step further. It’s actually an approval with conditions. Rather than relying on verbal information, you provide proof of everything including:
- Pay stubs for the last 30 days
- W-2s for the last 2 years
- Tax returns for the last 2 years if you’re self-employed or work on commission
- Last 2 months of bank statements
- Proof of employment (employer’s contact information)
- Letters of explanation for any gaps in employment or negative credit information
Underwriters use this information to ‘qualify’ you for a loan. It’s a pre-approval because there will be conditions.
The lender must approve the property too, which isn’t a part of the pre-approval process. In fact, you should get a pre-approval before you look at homes, it strengthens your offer (more on that below).
If your qualifying factors meet the loan’s requirements, lenders write a pre-approval letter which includes:
- Home sales price
- Loan amount
- Down payment
- Loan program
The letter will also state the conditions you must satisfy before you get final approval. Most are property conditions, but some may be personal too.
The letter will also provide an expiration date. Most pre-approvals are good for 90 days, but each lender differs.
If you don’t find a home within that time, you can renew your pre-approval. Lenders need updated paystubs, asset statements, and to pull your credit again.
When do you Need a Pre-Approval?
The pre-approval is the ‘magic.’ It’s what sellers and real estate agents want when you ask to see a home.
It makes you a serious and capable buyer. Sellers (especially today during COVID), don’t have time to waste. They want buyers coming through that can buy the home if they choose to do so.
Without a pre-approval letter, you could be a nosy neighbor or have intentions to buy a home, but not the financing.
Sellers give more weight to offers from pre-approved sellers. With a pre-approval, sellers know buyers are more than halfway through the financing process. Since the mortgage often holds things up, knowing the risk is lower helps.
In a bidding war, many sellers take the pre-approved buyer’s bid over the buyer without pre-approval, even if the offer is slightly lower.
Increasing your Chance of Pre-Approval
When you’re ready to buy a home (usually a few months before), prepare your finances. The more work you put in ahead of time, the easier it is to get approved.
Try the following:
- Pull your credit here; it’s free. Look for any tradelines that need correcting. Late payments, overextended credit, or not enough tradelines hurt your chances. Bring your late payments current, pay your debts down, and make sure you have enough open tradelines to create a credit score.
- Lower your debts. Your debt-to-income ratio can make or break the deal. Ideally, don’t commit more than 43% of your gross monthly income to your debts. This includes the new mortgage payment. The lower your DTI, the higher your chances of approval.
- Get your money straight. Lenders want two months of bank statements to see your down payment funds. Put your funds in one account and let them sit there. If you have large deposits within the last 2 months, lenders may need proof of origination to ensure you didn’t borrow the funds.
- Stabilize your employment. A 2-year employment history is ideal. If you change jobs, try staying within the same industry. If you change jobs, you must prove you have the training/education to succeed. Lenders need to know you can afford the loan for the foreseeable future.
Do What’s Right for You
If you don’t know how much home you can afford, get a pre-qualification early in the process. Get an idea of where you stand and what you should fix. When you’re ready to look at homes, secure your pre-approval.
You’ll be a stronger buyer and have more options with that piece of paper in your hand. It’s a tool all buyers should have before looking at homes.