Aug 23, 2022 -
You’re ready to go shopping for a new home and need to know how much of a mortgage loan you qualify for, but don’t really understand the difference between a prequalification and preapproval letter. Are they the same thing—and is one bet-ter than the other? The answer is that it depends.
Fannie Mae’s website states that “you’ll hear the terms mortgage prequalification and preapproval used quite a bit on your homebuying journey. These terms may sound similar, and they are often used interchangeably, but they can have signifi-cant differences.”
In practice, each lender defines what prequalification and preapproval pro-vide in terms of promises and respective documentation. Not all lenders provide both—but most provide at least one option. Behind the scenes and as a general rule, both processes use automated underwrit-ing systems on the front end to analyze credit history, employment, income, assets, debt, and loan attributes to meet guidelines of Fannie Mae/Freddie Mac or government loans (FHA, VA, and USDA Rural Housing).
The following are three customary examples found in the market today:
PREQUALIFICATION is typically a quick and simple process that does not necessarily involve a conversation or meeting with a loan originator. It’s an online process providing instant response by way of an automated underwriting system based on the information provided. A prequalification is based on stated information and assumptions that are not verified to give the homebuyer a general loan amount and monthly payment range. This tool is best for someone in the very early stages of planning and is not ready to work with a Realtor or make an offer to purchase.
PREAPPROVAL takes the prequalification process a step further with the lender reviewing some of the information and assumptions provided at application. What and how the lender reviews in this extra step varies by institution. For example, a lender may review paycheck stubs and W-2s to confirm income. Most preapprov-als are still subject to final underwriting approval, so it’s not a commitment or promise to lend. Preapproval does provide buyers and sellers with an initial level of confidence and is commonly requested when making an offer to purchase.
UNDERWRITTEN PREAPPROVAL loan commitment takes the process further by providing a credit approval with a full review of supporting documentation, so it’s contingent only to property-specific items such as a clear title, an acceptable appraisal, flood certification, and homeowner’s insurance. In today’s market with high buyer demand and low inventory, the underwritten preapproval loan commitment provides buyers with strong confidence and leverage when competing with multiple offers.
These three examples of qualification/ approval help buyers prepare and set expectations, but they do not commit them to any one lender while looking for a home. Once a property is identified and under contract, the buyer can request loan estimates from multiple lenders to review the rate, terms, and closing costs to make an informed decision. Loan originators are a great resource and can advise on mortgage planning early
in the process, such as first-time homebuyer programs and potential down-payment assistance and grant opportunities or the pros and cons of a 15-year versus a 30-year term. In the event you do not qualify, ask lots of questions and plan for the steps necessary to improve any areas of weakness.
It’s important to remember that it’s not how much you can qualify for; rather, how the full payment with principal, interest, taxes, and insurance fit into the household budget and overall financial plan. There are many other costs associated with homeownership such as lawn mowers, ladders, repairs, and maintenance, so preserving your savings/reserves after the new purchase is also critical.
Now that you have a better understanding of the commitment level of lending options available before you have an accepted purchase and sales agreement, let’s discuss the next steps. The process of buying a home requires the help of many different real estate professionals to get across the finish line, including a Realtor, attorney, title company, home inspector, appraiser, and lender. The prequalification/preapproval process is typically at no cost and provides the valuable financial foundation before the emotional fast-paced home search and negotiations begin. Community bank loan originators have strong relationships to local real estate professionals and can assist in the coordination and referral process. A great first step in the journey is to discuss your goals early on with a local mortgage loan originator at a community bank.
Edward Bidlack, who wrote this article, has more than a decade of experience as a Mortgage Loan Originator and has expertise in all kinds of lending at Ledyard Bank. Contact Ed here.