While following the home buying checklist, a buyer may come across a lot of unfamiliar terminologies. There may even be words that are near related but mean two different things. Two of the mortgage terms they may read our pre-qualification and pre-approval, both of which are very important in your journey for securing an offer on your dream home.
While these terms may sound similar, they are not the same.
- Pre-qualification is an early part of the home buying journey whereby the buyer gets an estimate of their potential loan amount. Essentially, it’s a ballpark number that could be lower once the lender confirms the pre-approval.
- However, pre-approval is essentially a lender’s way of establishing the homebuyer will receive a specific amount because they have the credit to do so.
Because so many individuals get confused with these terms, we aim to make it as easy as possible to understand how they work in the home buying process.
What is mortgage pre-qualification?
A mortgage pre-qualification is when a bank provides a homebuyer an estimated loan amount it is comfortable lending the homebuyer based on the info the homebuyer has provided the bank. The lender will run a credit check and look at the homebuyer’s finances to provide a rough estimate of how much the buyer may borrow. Generally, this is a ceiling amount (the most the bank is willing to lend), and it could change based on several other factors, such as credit information, finances, payment history, and employment status. For many homebuyers, this step is done early in the process to get a better idea of the different mortgage options that may be available for their specific circumstances. It should be one of the first steps to take.
When a lender provides pre-qualifications, there are a few considerations the potential buyer must keep in mind:
- A pre-qualification doesn’t mean the lender is looking at past payment history and financial situation, so there’s still a chance a homebuyer may not qualify to receive the loan amount they want, so it’s best not to look for a home at this phase.
- The lender will only provide a ballpark estimate following a pre-qualification. This loan amount can change after the lender looks into the homebuyer’s situation even further.
- The pre-qualification amount the homebuyer receives is based solely on information the buyer provides.
While a pre-qualification isn’t always an indicator of a homebuyer’s loan amount, it’s beneficial to have. In fact, some in the market require a pre-qualification letter to prove the buyer can perform their side of the contract.
What is mortgage pre-approval?
A pre-approval is the lender’s way of checking the homebuyer’s credit history, finances, and ability to obtain a loan for a specific amount and can pay back that loan. The homebuyer will have to complete an application that includes financial information, basic information regarding their bank accounts, how much they intend to pay as a down payment, and the desired overall amount they wish to borrow. A pre-approval allows the homebuyer to make a home purchase with a specific amount the lender has offered them to borrow.
A pre-approval is good for 90 days and details the specific loan amount the homebuyer can receive. A pre-approval can also indicate the interest rate the homebuyer can expect to pay. Another benefit of a pre-approval is learning about the mortgage choice and planning for a fixed or adjustable rate. A loan that promises an adjustable-rate means that the interest can change over time. A fixed-rate holds the same interest rate over the life of the loan, meaning most mortgages will be the same for the set number of years in the contract.
For any homebuyer, a pre-qualification and pre-approval go hand in hand. However, it’s often best to know how they are different and where they relate to one another in the process. Here are some of the differences between the two:
- Filling out a mortgage application: A homebuyer must fill out a mortgage application to receive a pre-approval, but they can obtain pre-qualification without an application.
- Paying an application fee: Some pre-approvals will require an application fee, but most pre-qualifications do not require the potential buyer to pay these types of fees.
- Credit history and payment check: A pre-qualification only looks at information the homebuyer provides, which may not include a history of payment or credit. A pre-approval, however, requires this check.
- Finance review: Pre-approvals require a finance review, but a lender won’t have to look at current finances for a pre-qualification.
- Down payment estimate: A pre-qualification gives an estimate, but it may not include a down payment. However, a pre-approval will require a homebuyer to list a down payment amount (because it can impact the loan amount and more).
- An estimate for a loan: Pre-approvals most often tell the lender how much they can get, but a pre-qualification provides a ballpark estimate that may not be what the homebuyer expects.
Which party benefits from pre-qualification and pre-approval?
You’ll be delightfully surprised that ALL parties benefit when a prospective homebuyer does their hard work earlier in the buying process. Here is how each party benefits:
- You, the homebuyer. The most important beneficiary, of course, is you. You get to answer the question, “How much mortgage can I afford?” There are simply too many variables to know in order to that question to get a straight answer (debt, income, credit history, etc). Instead of fumbling around with spreadsheets and mortgage calculators, you get a real lender to tell you the exact amount.
- The lender. By engaging with a lender early, you establish a relationship and they get to know you. Furthermore, by knowing the homebuyer’s financial numbers, they can provide them with more accurate mortgage amounts.
- The real estate agent. When an agent knows how much their clients have been approved for, they can spend more time focusing on properties within the buyer’s budget. No more wasting time, no more guessing.
- The seller. The security of knowing your buyer is good for the money and that the home won’t fall out of escrow is assuring. Sellers are more likely to choose homebuyers who are already approved and qualified.
Why homebuyers should get both
While pre-qualification and pre-approval can differ significantly, one of the best things a potential homebuyer can do is get both completed. A pre-qualification shows the lender that you are a serious homebuyer and you are building a relationship with the lender early. A pre-approval shows sellers that the buyers are serious, and it helps to provide them with an exact loan amount so they can make a fair offer on a house that falls in line with market value and/or the seller’s asking price.
Many realtors these days request both pre-qualification and pre-approval, especially from homebuyers with credit issues.
The most significant benefit of all is for the homebuyer. The homebuyer will know how much they can receive for their mortgage loan and make offers based on their budget.
Caveats and concerns
It is important to remember that the amount of mortgage you will qualify for is the maximum. It is the amount that the lender feels you can afford, but it is not necessarily the amount that you want to pay. It sometimes is advantageous to be conservative here－just because you can afford that much house doesn’t mean you should buy it. Consider your entire debt/income ratio and your future income flows.