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The Difference Between Prequalification and Preapproval

Happy homeownersWhy is a mortgage Preapproval so much better than just getting Prequalified?

Many people think they are the same but they’re not.  In today’s market you want the right one to save you time, money and unnecessary legal headaches.

A prequalification is a lender’s estimate of how much you could be eligible to borrow based on information you supply.

Preapproval means the lender is ready to make you a mortgage loan based on information and documentation you provided at the time you requested the preapproval.*  A prequalification doesn’t mean a loan can be done; especially since today’s lender guidelines are interpreted much stricter than in the past.  That is what is meant by “credit remains tight.”

The prequalification process usually goes like this: a buyer contacts a mortgage broker; the broker asks them how much they make, how much of a down payment they have, and if their credit is good.  Sometimes, they pull a credit report.

The broker sends back a letter stating the buyer is ‘prequalified’ for a specific loan amount and purchase price.  The prequalification is full of disclaimers, as it must be, because the lender has not reviewed any of the borrower’s documents.

In contrast, a preapproval is basically an underwritten loan in terms of credit, income, and assets.  What remains to be reviewed are the purchase agreement and appraisal.  For a preapproval, documentation was provided by the borrower and reviewed by the lender; including a two-year work history, paystubs, tax returns, and bank statements.

A prequalification doesn’t reveal issues that could be a problem, including…

  • Income received, but not reported on federal tax returns
  • Adequate savings for down payment, but not enough for required reserves
  • Gaps in work history in past two years
  • Inconsistent or declining income over past two years
  • No way to prove where down payment money came from

With a prequalification, the hopeful home buyer doesn’t know that they’re not going to be able to get a loan – resulting in disappointment, lost time, and deposit money at risk or wasted on inspections and an appraisal.

With a preapproval, these issues are identified up front.  Sometimes, with the benefit of time, there are workarounds.  If not, the buyer learns what they can qualify for and shop accordingly.  Another reason to get a preapproval is because many markets have low inventory; there aren’t enough homes for sale.  This leads to multiple offers and cash buyers being favored.  In such a market, the prospective buyer wants every possible advantage and for their offer to be taken seriously.

Considering the time, energy, and emotional strain of buying a home; a preapproval is worth the extra effort.  Not only can it shorten the time to close, but the buyer has more confidence putting down an earnest money deposit and paying for inspections.

Another way to leverage preapprovals is to have the lender prepare multiple versions with different loan amounts.  For example, when negotiating on a $500,000 house, with a 20% down payment (borrowing $400,000), you wouldn’t provide a preapproval letter saying you’re approved for a $1 million dollar loan.  You want one that says you’ve been preapproved for $400,000.  Otherwise the seller will think you can afford the higher price they’d like to sell the home for and they’ll be less willing to accept your lower offer.

*Prequalifications and preapprovals are subject to acceptable review of the appraisal and purchase contract

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