Pre-Approval vs. Pre-Qualification: No, They’re Not the Same
Believe it or not, the homebuying process doesn’t usually start with hiring a real estate agent. It begins with getting the pre-qualification process started and then obtaining a mortgage pre-approval letter.
And no, a pre-qualification letter and a pre-approval letter are not the same thing.
Let’s explore what each of the steps of this process looks like and find out which is more important — pre-approval vs. pre-qualification.
How It Works: Mortgage Pre-Qualification
If you’re even remotely thinking about looking for a new home, you should get pre-qualified for a mortgage before doing anything else — especially if you’re a first-time homebuyer. Taking this step will allow you to get a preliminary idea of what your price range should be and what types of loans could be a fit for you.
Consider establishing a relationship with a mortgage lender if you haven't already. Do your research before selecting a loan officer to work with. You can do this by asking people you know or by conducting a simple search on Google. You should find out your lender's reputation, credibility, and turn times, as well as their success rate with buyers. We recommend working with a lender that is not only reputable, but that has a proven track record.
If you’re a seller, contacting the lender that has written the buyer’s pre-qualification or pre-approval letter is also a good practice. You’ll want to ensure that what is written in the letter is verifiably true and that the terms of the buyer’s offer can be met.
For buyers, your lender can help you think about your financial situation. In order for you to obtain a pre-qualification letter, the lender will ask you to provide basic personal and financial information, including income information, such as:
- Pay stubs
- Bank statements
- Credit reports/credit history
- Tax returns from the last two years
- Details on any debts
- Other information that impacts your assets and monthly income
Have these financial documents ready to submit to your lender if you are a serious buyer.
At this stage, you’re not required to partake in a rigorous assessment regarding your financial situation. You’re not filling out a loan application just yet. The pre-qualification process doesn’t involve entering into any contracts. You’re just beginning to understand your current financial situation and how it relates to your eligibility for obtaining a mortgage.
If there are issues or details regarding your personal finances that require clarification or additional documentation in order to obtain a mortgage loan, you’ll discover this during the pre-qualification process. This is the time to address those issues and obtain any needed documentation before moving forward. Because this part of the process can take some time, this is also why we recommend getting started long before you start house-hunting.
If you decide to write an offer on a home and use your pre-qualification letter, a seller will not view this as favorably as they would a pre-approval letter. Your pre-qualification letter merely estimates how much home you can afford, it doesn’t indicate a precise amount of money and it isn’t a guarantee of a loan offer.
How It Works: Mortgage Pre-Approval
Once you’re getting serious about homeownership and exploring the housing market, it’s time to start the pre-approval process.
Do you remember that list of financial documents you needed earlier? Now’s the time to get these documents to your lender so they can determine what mortgage options you’ll have at your disposal.
It’s extremely beneficial to do this before you start home-shopping because:
1. It’s wise to decide on the exact amount you feel comfortable spending and can afford before you start your home search.
2. Once you’re pre-approved, you can move quickly to write an offer and not scramble to submit the paperwork you need for your pre-approval.
3. Sellers take buyers more seriously who have completed this step before visiting a home.
Many buyers who are not pre-approved miss out on homes because they didn’t do the work upfront. As a result, they’re less appealing to a seller when compared with a pre-approved buyer.
All the financial information your lender gathers from you will help them determine the home loan amount you qualify for. Here’s what they’re looking for:
Debt-to-Income (DTI) Ratio
A debt-to-income (DTI) ratio is a key metric lenders use to gauge a borrower's qualification for a loan. To calculate your DTI ratio, divide all your monthly debt payments by your gross monthly income. This is a risk assessment formula, and lenders are looking to see that you’ll be able to pay your mortgage. They want to make sure you won’t be spread too thin, and they need to see that you can consistently make payments on schedule.
In general, most lenders want you to have a DTI ratio of 43% or less before agreeing to write you a pre-approval letter.
Mortgage lenders will also run a credit check to determine what types of home loans you can qualify for. Conventional loans require a credit score of at least 620, while Federal Housing Administration (FHA) loans can be approved with a score of 500 and above. The higher your credit score, the better your mortgage rates will be.
Once the lender analyzes your data and determines that you are a viable borrower, they will tell you what purchase price you are pre-approved for. They will also discuss different mortgage options based on your pre-approval, the current interest rates available, and the amount of down payment required. At this stage in the process, you can now shop for a home confidently, knowing you can present a solid offer to a seller with a pre-approval letter.
A good practice is to update your pre-approval after every three months. A lot can change in a few months, and if you experience any job changes, increases or decreases in your income, bonuses, or debts being paid off, this can lead to changes in your mortgage options.
During the pre-approval process and until you close escrow on a home, you should disclose all pertinent information.
It is imperative to be honest with your lender and to keep them apprised of any changes to your financial situation. If you don’t, this may cause you problems down the road. A good rule of thumb we use at Aalto is if you have to ask yourself whether or not to discuss something, then it’s probably something you should let your lender know about.
Pre-Approval vs. Pre-Qualification: The Key Differences
Here are the main differences between getting a pre-approval vs. pre-qualification:
- The first step in the process.
- You get an estimate of how much you can borrow based on the information you provide your lender.
- No mortgage application or formal paperwork is required.
- Getting pre-qualified isn’t as effective as a pre-approval letter.
- The second step in the process.
- You get an exact estimate of how much you can borrow based on the information you’ve provided your lender as well as their own findings.
- This requires a credit check and document submission, and you must also complete a mortgage application.
- A pre-approval letter holds more weight than a pre-qualification letter and speeds up the homebuying process.
Some FAQs: Pre-Approval vs. Pre-Qualification
Q. Does pre-qualification mean approval?
A. No. A pre-qualification letter merely estimates how much home you can afford. Your lender doesn’t provide you with precise information until you undergo the pre-approval process.
Q. Does a pre-qualification affect your credit score?
A. The pre-qualification process won’t negatively impact your credit score. However, going through the pre-approval process may.
Q. Does pre-approval require a hard inquiry?
A. Yes. When a mortgage lender reviews your credit report during the loan application process, their request is considered a “hard inquiry” and usually hurts your credit score.
Q. Can a loan be denied after pre-approval?
A. Yes. A pre-approval letter indicates that you currently meet the lender’s essential criteria. However, your circumstances could change. For example, if you lose your job, your DTI ratio could increase beyond the 43% threshold, making you no longer eligible for a loan.
Q. Do you need a pre-qualification letter to buy a house?
A. No, but it will help sellers determine whether or not you’re a serious buyer. If you really want to be taken seriously, you should obtain a pre-approval letter.
Pre-Approval Letters Are More Important
When it comes to pre-approval vs. pre-qualification letters, this is worth repeating!
A pre-approval letter will be much more attractive to sellers since it indicates that you are much further along in the mortgage process than the pre-qualification stage.
If you’re considering moving forward with a pre-approval, we recommend examining the current rates and where they could go based on current economic predictions. By taking steps to obtain your pre-qualification and pre-approval letters, you’ll know what you can afford and you’ll understand your financial situation before committing to buying a home and locking in an interest rate.
And if you have any questions, Aalto is here to help! We’re dedicated to demystifying the real estate process and providing you with the tools you need to buy or sell your home. Are you ready to discover how Aalto works for you?
Aalto is a real estate broker licensed by the State of California, License #02062727 and abides by Equal Housing Opportunity laws. This article has been prepared solely for information purposes only. The information herein is based on information generally available to the public and/or from sources believed to be reliable. No representation or warranty can be given with respect to the accuracy of the information. Aalto disclaims any and all liability relating to this article.