If you're in the market to buy a home, you may have heard the terms "pre-qualification" or "pre-approval." While both of these terms sound like they are the same thing, they are actually different.
In fact, there is actually a major difference between the two. So, while the terms are often used interchangeably in the home-buying process, they refer to different steps in being approved for a mortgage to finance the cost of a home.
All homebuyers should understand the key differences between pre-qualifying and being pre-approved for a home purchase. This helps make the entire home-buying process less stressful and determines what is still left to be completed before you can head to the closing table to officially take ownership of your new home.
Both of these terms refer to different steps in the mortgage application process, and both are essential steps to take if you want to buy a home. Below is an explanation of each, including the similarities and differences.
What is Pre-Qualifying for a Home Purchase?
Pre-qualifying for a home purchase is one of the first steps that any prospective home buyer must complete. It is a relatively quick process in which the lender is given a general financial overview of the applicant.
Most pre-qualifications can happen in just a few minutes, and they can be completed online in many instances, though some must be done over the phone.
During pre-qualification, the lender will look at the applicant's total income, debt and assets, as well as their credit score and credit history. From this information, they will determine how much they are willing to extend in a mortgage, as well as set an interest rate.
What You Get with a Pre-Qualification?
When a pre-qualification is approved, you may be provided with some mortgage options. Depending on your financial situation as well as the location of your home, you might be extended an offer for a convention, FHA, VA or USDA mortgage.
The lender will give you all the basic details of each and allow you to choose which one would be the best fit for you. Keep in mind that not everyone will be offered all of these options. A VA loan, for instance, is only offered to veterans, while a USDA loan must be used for a home that is located in a rural area of the U.S.
Once you make your decision, the lender will provide you with a pre-qualification letter. It will state the type of mortgage you have selected as well as the terms of the offer.
Why is Pre-Qualifying Important?
While pre-qualification isn't a required step in the home-buying process, it does give the borrower a general idea of how much they might be able to afford in a home. This could prove particularly important to a borrower who has never purchased a home before or who isn't quite sure of their complete financial picture.
A pre-qualification is basically an internal document that a borrower will use for their own information. It's a measuring stick that they can use to search homes within a certain price range, and it also allows them to create a baseline budget around the numbers that are presented in the letter.
The document is certainly useful during the home-buying process, but many real estate agents and sellers will require a prospective home owner to receive a pre-approval before they will move forward with the sale of a home.
What is Pre-Approved for a Home Purchase?
A pre-qualification is a preliminary financial check that determines what you likely will be approved for in a mortgage. Once a home sale price has been agreed upon between the buyer and seller, the mortgage will advance to the next step.
This is known as the pre-approval process. It's a process that's more involved that pre-qualification. In this process, the borrower will have to complete an entire mortgage application, and not just the basic financial information that they provided during pre-qualification.
In addition, the lender will require the borrower to provide them with supporting documentation to back up the numbers they put on the pre-qualification application.
Some of the most common documents a lender will ask for are pay stubs and copies of tax returns, which will verify your income; copies of bank statements, which will verify your assets; and potentially outstanding loan statements, to verify your total debt.
The pre-approval process will determine what your final interest rate will be. Some lenders will even allow their borrowers to lock in the interest rate at this point, if they accept the mortgage that is extended to them. In these cases, the rate will typically be guaranteed for a period of 30 to 60 days, to allow for time to close on the home.
What is Pre-Approval Important?
Many real estate agents won't even show people homes for sale until they have a pre-approval letter in hand from their mortgage company. That's because they don't want to waste their time -- or the seller's time -- showing people homes that they won't be able to afford.
When real estate agents make a purchase offer on your behalf, they will often include a copy of your pre-approval letter. This serves as proof to the seller that you can indeed afford the home, which will help convince them to agree to sell the home to you.
The pre-qualification often isn't enough for real estate agents, as it isn't an official extension offer from a lender. Just because a borrower is given a pre-qualification doesn't mean they will be approved for that amount.
A pre-approval, however, does tell them that information.
Should You Get Pre-Qualified and Pre-Approved?
Getting pre-approved for a home purchase is an essential part of the process. In fact, it's a step that you likely will not be able to avoid if you intend to obtain a mortgage to finance the purchase of your home.
Getting pre-qualified for a home purchase, by contrast, is an optional step. This doesn’t mean it's not valuable, though. Obtaining a pre-qualification will allow you to see how much you might be able to afford, which could save you from wasting time searching for homes that might be out of your price range. It will also show you what you might need to do to improve your financial situation if you aren't happy with the loan terms offered or the homes that fall into that range.