If you started shopping for a home without getting pre-approved, you went ahead of yourself. The first step you should take is getting pre-approved. Notice that we didn’t say pre-qualified, right? There’s a difference and one that many people don’t realize.
We’ll help you understand the differences below so that you can make the most of your home buying process.
What is a Pre-Qualification?
A pre-qualification is when a lender estimates how much you can afford. Yes, we said estimate. That sounds funny, but it’s an estimate because they don’t formally verify your information. They take your word regarding your income, assets, credit score, and employment information.
The lender uses the information that you provide to come up with an estimate of how much loan you can afford. It is not a commitment to lend. That’s the most important thing to understand. A pre-qualification, even if it’s in letter form, doesn’t mean the lender will give you a loan.
It means that they listened to your financial information and formed an opinion of what you can afford. You can use this step when you are thinking about buying a house, but aren’t sure what you can afford. Sure, you may know how much you want to pay, but really what will a lender approve, that’s the big question.
Many people use this step as the first step in deciding if they are ready to buy a house. Let’s say you thought for sure you could borrow $300,000, but when you get pre-qualified with a lender, they tell you that you only qualify for $200,000. That will certainly change your plans. That’s where the pre-qualification comes in handy.
What is a Pre-Approval?
The pre-approval is similar to the pre-qualification, except the lender verifies your qualifying factors. In other words, you must prove everything that you state on your loan application. This includes:
- Providing your last two pay stubs to prove your income
- Providing your W-2s for the last two years to show your income
- Providing your tax returns for the last two years if you are self-employed or get paid commission
- Providing your last two months of bank statements or investment statements to prove your assets
- Providing permission to pull your credit report
Lenders use this information to pre-qualify you for a loan. The pre-qualification is a conditional approval for a loan. It means the lender approves your income, assets, and credit score, stating that you qualify for the loan program and loan amount stated.
The pre-approval letter will include conditions you must meet to close the loan, but it’s an agreement to lend you the money, as long as you meet the stated conditions.
When do you Need a Pre-Approval?
If you are ready to look at houses, you need a pre-approval letter. In fact, many sellers won’t waste their time showing you the house if you aren’t pre-approved. Sellers want to know that you are a serious buyer and that you have the capability to buy the home. Most sellers don’t want to take a bid from someone that isn’t pre-approved. Why take the chance of your financing falling through? At least with a pre-approval, the seller can feel somewhat certain that you’ll follow through with the purchase.
If you aren’t quite ready to buy a house and just want to know what you can afford the pre-qualification stage may be enough. But, if you are getting close to actually shopping for a home, pull the trigger on the pre-approval. It provides so much more information and is good for 60 – 90 days. If you don’t find a home before it expires, you can always ask the lender to re-qualify you for the loan.
What’s in a Pre-Approval Letter?
So what’s the magic inside the pre-approval letter that sellers need so badly? It includes:
- The loan program you and the lender chose – Some sellers don’t like FHA or VA loans, for example, so they want to know what type of financing you have because it may alter what the seller has to do or pay for at the closing
- The loan amount – The seller can see how much you are approved to borrow and how much of a down payment the lender approved. This way the seller can tell if you can afford the price of his or her home.
- Purchase price – The letter will also include the maximum purchase price you are approved for
- Interest rate – The lender will base your approval on the current interest rates
A pre-qualification has its benefits, but only in certain situations. If you’re past the point of thinking about buying a home and are just ready, you need a pre-approval. You need to know if any lenders will give you a loan and at what terms. We suggest getting a pre-approval from at least three lenders. This way you can compare the offers and decide which one is right for you.