The home buying process comes with a language all its own, and two of the terms you may have heard are pre-qualified and pre-approved. While both can be essential parts of obtaining a mortgage and buying a home, you may not know what they mean. Check out the information below to learn how each term may benefit you during your home search.
What Does it Mean to Pre-qualify?
When you pre-qualify for a home loan, it means you’re getting an estimate of how much you may borrow based on the information you provide about your finances and your credit check. While it isn’t as formal as being pre-approved, getting pre-qualified is an excellent first step when you begin your home search, as it will help you establish your budget and know how much you may borrow. This process will also introduce you to the various mortgage options you have to choose from.
Information needed for prequalification includes:
- Credit check
- Income information
- Debts and assets
- Bank account information
- Down payment amount
The pre-qualification can be completed online, over the phone, or in person. You’ll receive a prequalification lender, which you can use to show an agent or seller that you’re serious about buying. Although it can be helpful, a prequalification isn’t seen as being as serious as preapproval. The lender goes off the information you provided and does not verify everything you’ve given them is correct, up to date, and comprehensive. Meaning, while you may get a loan for the amount stated, it can also change when a lender does a more thorough check.
What Does it Mean to be Pre-approved?
The preapproval process involves a lender investigating your income, assets, credit history, and debts before providing you with an amount they believe you can afford. Getting pre-approved confirms to the seller that you’re serious about buying their home and that you can secure a mortgage, making you more likely to complete the purchase. Being pre-approved can be extremely valuable in a competitive market, as it will help you stand out from the other homebuyers.
You don’t have to receive prequalification for preapproval. If you know you’re financially prepared to buy, you can decide to move ahead to the preapproval process.
Information needed for preapproval may include:
- Credit check
- Paystubs from the last thirty days
- Bank statements from the previous two months from all accounts
- Investment account statements from the last two months
- W-2 and 1099 statements from the previous two years
- Federal tax returns from the last two years
- Driver’s license
- Social security number
- Total monthly expenses
- Down payment amount
If someone is helping you pay for the home, you’ll need a gift letter signed and dated by the individual assisting you.
Once you submit this information to a lender, you should receive their decision within ten business days. If you are pre-approved, you’ll receive a preapproval letter informing you of the offer to lend you a specific amount for sixty or ninety days, along with the type of mortgage the lender is willing to offer. Since the lender verifies the information you provided, this is a much more serious step than prequalification.
While you may receive preapproval for a mortgage, it’s important to remember it does not guarantee a mortgage. If there is a change to your income, assets, or debt level before the closing date, a lender may decide to deny the loan.
Prequalification and preapproval are just a part of the mortgage application process. Check out this list of nine things to consider before and during this critical part of the journey to finding your next home.
1) Check (and Repair) Your Credit
When you first start thinking about buying a home, you’ll want to do a deep dive into your credit. Check with each of the big three reporting agencies (TransUnion, Experian, and Equifax) since each may have different information. If there are errors on your reports, reach out with corrections and required information.
If your credit is just not great, there are ways to improve it. Here’s are a few suggestions:
- If you don’t have much credit, look for ways to build your credit record. Seek out a starter credit card, make regular, small charges and pay them off immediately. Look for programs that report your current rent and utility payments to the credit bureaus so that you can use your on-time payment record to build your credit score.
- If you have damaged credit, work on paying down existing debt and making on-time payments going forward. If you pay your rent and utilities on time, seek out reporting programs to allow you to use your positive payment history to rebuild your credit score.
- As you pay off credit cards and loans, don’t close out the accounts. Leave them open and at a zero balance, or use them for occasional, small purchases that you then pay off immediately. Part of your credit score comes from the length of time that you have had your accounts, so closing out an older account can have a negative impact.
2) Organize Your Financial Records
One of the biggest things you’ll have to do during the process of applying for your home loan is obtaining and providing a wide variety of financial records to submit to underwriting. Start gathering these now. When you apply, you’ll need the following:
- Tax returns (generally two-year’s worth)
- Pay stubs, 1099s, W-2s or other proof of income
- Bank statements and other asset statements
- Photo ID
If you are using gift funds from a family member to finance your down payment, closing costs, or reserves, you will need to present a letter from that donor. The lender may request additional documentation, as well. Be sure to find out what donors and uses are acceptable for your particular situation.
3) Find a Lender
You will need to find a lender to work with on your mortgage application. You may find someone at your local bank or credit union, through an online lending platform, through a referral from a friend, or through your real estate professional. Make sure that you feel comfortable working with and communicating with your chosen lender so that you will feel confident throughout the process.
4) Consider a Variety of Loan Options
Don’t feel locked into a conventional, 30-year loan with a 20 percent down payment. While that scenario works for some buyers, it doesn’t work for everyone. Work with your lender to determine what types of financing options you qualify for and what types of financing will help you fulfill your goals.
For example, if you are open to a larger monthly payment, you may find that a 15-year loan makes more sense than a 30-year loan. Just remember, there is no one-size-fits-all solution.
5) Get Pre-Approved
It will be important for you to work with your lender to obtain pre-approval before you begin looking for your home. This will allow you to better determine your budget and timeline. In addition, pre-approval helps you to make a stronger offer once you find the right home for you.
6) Determine Your Budget
Once you know how much you’ll potentially be approved for and what your interest rate will be, you can create a budget based on your down payment and your desired monthly payment amount. Remember, just because you qualify for a large amount doesn’t mean that you will want to spend that much. Let your comfort level determine your budget.
7) Don’t Forget the Extras
Remember, you don’t just pay the monthly mortgage and required down payment. There is an earnest money deposit (EMD) that you will need to have available as well as reserve funds that you will need to show. You’ll have closing costs, insurance costs, and other expenses associated with moving and setting yourself up in your new home. Try to keep an eye on the big picture when making your decisions during this time.
8) Avoid Major Purchases and Changes to Your Credit
You may want a brand new car to park in your new driveway or a houseful of new furniture and decorative items. While it would be fun to have those things in place on moving day, you’ll probably need to hold off until after the closing. That’s because changes to your credit report or to the amount of debt you carry can have major negative consequences on your mortgage underwriting and approval process.
9) Expect the Unexpected
A lot of things can happen on the journey to homeownership. You may find that your budget is different than you thought or that you have to make some compromises along the way. You may also find that some parts of the process you dreaded turn out to be easier than those things you thought were no-brainers. Stay open and stay in communication with your reliable real estate agent or broker to ensure that you are always in the best position to make good decisions.
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