What’s the difference between Pre-Qualification and Pre-Approval?
The short answer is Pre-qualifications don’t verify debt-to-income, but Pre-approvals do.
If you’re thinking about buying a home, you should know whether a bank will approve your mortgage request. The are two ways to determine this – one is good, the other excellent.
The good way is via pre-qualification. The excellent way is via pre-approval. Here’s what you need to know about both.
Why Is It Good To Get Pre-Qualified?
Getting pre-qualified for a mortgage is a quick and easy process. Via phone, email or internet, your lender will ask you for some basic information about yourself and — based on what you share — you can know whether you qualify for a mortgage.
Pre-qualification questions vary by lender but often include the following :
- What is your credit score or credit rating?
- What is your annual income?
- How long have you been employed at your current position?
- Are you self-employed?
- How much money do you have “in the bank”?
Your lender may also ask whether you’ve had a bankruptcy, short sale or foreclosure within the last few years; and whether you’re a U.S. citizen.
The answers to these questions can a help a lender determine for what mortgage programs you may be eligible. For example, if you have very little money in the bank and plan to buy a home with 2-units or more, your lender will limit your pre-qualification to FHA mortgages and VA loans.
Similarly, if your credit rating is high with no outstanding judgments or liens, your lender may pre-qualify you for a wide range of mortgage products which are unavailable to buyers with low credit rating.
Based on the information you share, your lender will also assign your purchase to a maximum purchase price. This is good information to share with your Realtor.
This is why pre-qualification letters are only “good”. They’re a non-verified guess of how much home you can afford.
Why Is It Excellent To Get Pre-Approved?
Getting pre-approved for a mortgage takes more time than getting pre-qualified. The extra time pays off wonderfully, too.
In the mortgage pre-approval process, your lender will go deeper as compared to a prequalification. Instead of just being asked about your income, your assets, and your credit, you will be asked to prove it.
For example, your lender will ask about your money “in the bank” and whether it’s from your job; or, from a 401(k) withdrawal; or, from a cash gift for downpayment; or, from some other source. The funds will be verified with bank statements.
Your lender will also ask to review your most recent W-2s and tax returns in order to confirm your “eligible income”. This figure is then compared to your credit report to determine your personal debt-to-income (DTI) ratio. Debt-to-income is a key mortgage qualification standard.
Buyers with a debt-to-income ratio below 40% may be eligible for all available loan types include conventional financing, FHA and VA mortgages, and USDA. However, buyers with a DTI between 40-45% may be limited to products via the FHA or VA.
Pre-approvals also uncover hidden collections, judgments and liens which may stand between you and your approval. Many Americans are harmed by “errors” on their credit report. If you turn out to be one of them, finding a credit report error after you’re under contract for home can carry significant costs — including the loss of your earnest money.
For all of these reasons, home sellers and their REALTORS® often insist that home buyers submit a valid pre-approval letter along with their initial offer for the home.
Sellers don’t consider offers from people who haven’t taken the time to determine if they can even get approved for a loan in the first place. This is why pre-approval letters are important. They’re typically required to even offer on a home.
When you contact a lender, then, be open and honest about your financial background.
Today’s mortgage lenders perform tons of due diligence; much more than 10 years ago. Whatever you attempt to “hide” from a lender, they’ll ultimately uncover — and hiding information may be cause to deny your loan.
Even if it’s something as simple as a side-business you’ve recently started which currently earns absolutely no income, share it with your lender. Ultimately, the business may not affect your approval but let your lender determine what’s important and what’s not.
You should also alert the lender if you’re carrying non-credit reporting debts such as a personal loan from a friend or family member.