Prequalification Explained

Whether you are a first time home buyer or a veteran of many sales, you should get pre-approved for your home loan before you even begin house shopping.    Many Realtors will insist that a buyer be pre-approved prior to beginning the house hunt and can recommend reliable lenders for you to speak with.

Pre-approval is different than pre-qualification – let’s look at what happens in each case.

Pre-qualifying a buyer is fairly perfunctory and can literally be done over the phone.  The lender asks for personal financial data such as all sources of income, long term debt such as car loans, amount of credit card debt,  any other debt for which a buyer is responsible (such as student loans or alimony and child support), rent/mortgage payments and available cash for a down payment.    The lender then calculates the ratio of gross income vs. monthly bills and comes up with a sales price and loan amount for which a buyer is likely to qualify.  That is the price range of a home that the buyer can buy.

Pre-qualifying is a good start to the home buying process, but it has room for error.  The answer provided is only as good as the data given by the prospective buyer.  If the debt or the income is misrepresented, the outcome of the pre-qualification may be incorrect. A much more thorough technique, and one that eventually has to be done in any case when purchasing a home, is to get pre-approved instead of simply pre-qualified. 

This involves going through the complete loan process to have a lender actually commit to lending a buyer a certain amount of money.  Completing this process makes the buyer a much stronger and serious candidate when presenting an offer on a property to the seller.   This is especially important is a market where multiple offers are commonplace.   A seller will nearly always accept an offer from a pre-approved buyer as opposed to one from a buyer who has not shown the motivation, foresight and commitment to getting their loan approved.

Paperwork involved in obtaining preapproval is all the necessary documentation needed when purchasing a home.  It includes a completed loan application, current credit report, usually a check to the lender for a home appraisal, 2 years tax returns, pay stubs, several months’ bank statements, and verifications of employment and mortgage/rent payments and potentially even more.   Based on these documents, a lender will then agree to lend money to a prospective buyer and will send a pre-approval letter to the buyer’s Realtor which can be included in an offer presentation to the seller. 

If a loan is denied, the buyer is informed of the reasons.   The usual reasons are insufficient income, high debt ratios, and/or poor credit.  Often home buyers have to work to clean up their credit so their credit score can improve, as well as pay off bills so their debts aren’t so high.   Understanding one’s financial status and buying power is crucial and such knowledge can allow a buyer to do what it takes to place themselves in a much better position to buy.  A denial can be a stepping stone to loan approval if the necessary steps are taken.