What is the difference between a Pre-Qualification and Pre-Approval?
Getting approved for a loan can be an involved process. Specific documentation is required and everything is scrutinized. This means a seemingly innocent document the lender requests at the 11th hour could cause the loan to be rejected. The weeks, and months, that both sides put into the transaction could go to waste with an underwriter’s decision. Your loan is not truly closed until you sign the documents at the closing table. That’s why as a seller it’s critical to make sure every potential buyer is not just prequalified but actually pre-approved. This may seem like semantics, but the difference is tangible and could save you weeks of potential trouble. In the same way, if you are a buyer looking to make an offer, you should understand the difference between these two. Here are a few differences between a pre-qualification and pre-approval.
Pre-qualification
A pre-qualification is the very first step in the loan approval process. Few real estate agents will show you a property without a pre-qual letter in hand. It is obtained by reaching out to your local mortgage broker, bank or credit union. Prior to issuing the letter, the lender will ask you a series of questions to determine the strength of your application.
Review of credit
The starting point is almost always a review of your credit score. Your score will either eliminate a handful of programs or put you square in line for others. It is important to note that a credit score for a loan application may not be the same as one you pull for yourself online. An excellent score will unlock more options and lower interest rates, and a poor score may give you limited options. Everything in the middle is usually tiered on a 20-point basis. That means there could be a huge difference between a 665 score and a 670.
Debt to Income
The lender will also review something called your debt to income ratio (DTI). The is a formula where the lender takes all the minimum monthly payments on your credit report and adds them to your proposed total monthly payment. This number is then divided by your gross monthly income (annual income/12). Each lender and program are slightly different, but the benchmark for a maximum DTI is generally 50%. If your DTI is above 50% you may have a tough time getting approved regardless of your score or down payment. Conversely, if your DTI is low it can help open doors for other potential programs.
Down-Payment
The final major pre-qualification item that is noted is the down payment amount. As is the case with your credit score, down payment is broken up in tiers for loan program purposes. with 3, 3.5, 5, 10, 15 and 20 being generally the most common percentages. You can put down a number between those, but you will have the same rate scale as the previous tier.
Once a lender has this information they can issue a pre-qualification letter which can be used to start a new home search.
Pre-approval
There are many people involved in real estate who have been burned by a poor pre-qual letter. The truth is that a potential buyer can say anything they want to strengthen their application. They may really even think they are telling the truth, but in reality, their income may less than they think, or they are not employed for a minimum amount of years. The only way to get past this is by submitting real documentation to a lender prior to house hunting.
There are several lenders who will submit an application complete with real paystubs, tax returns and a full credit report. Basically, everything except the signed contract, title and homeowner’s insurance will be reviewed. It is not an exaggeration to say that this can literally save a buyer weeks in the approval process. Once they find a house and have a signed contract they send that over. Then, the loan is more than halfway to closing. As we stated, at that point all that is needed is a review of the contract, title and homeowner’s insurance.
Gone is the guesswork on how an underwriter will review self-employed income or other items on the tax return. There is no hoping that the debt-to-income ratio is approved or the employment signed off on. If you are selling a home, you need to work with a real estate agent who knows the difference between a generic pre-qualification letter and an iron-clad pre-approval.
Conclusion
Starting out with a buyer, or as a buyer, who is at least a few weeks ahead of their competition is something that cannot be overlooked. Things happen at every stage of the loan process, but the main hurdles usually come with the tax returns and income documentation. Once you are past those 90% of the issues can be rectified. Whether you are selling a home or seeking to purchase, you need to know and make the most of the difference between pre-qualification and pre-approval.
