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Prequalification Vs preapproval

In this article, I will try to use one stone to kill two birds. I will provide you a guide on how to get preapproved for a mortgage loan and at the same time show you the difference between prequalification and preapproval. It is good that I start with the basics so that you have a full understanding of the topic. A wise man once said that the best way to start anything is to begin from the beginning. That is true. Imagine someone who wants to build a house and decide to start the house from the roof. This may sound funny but that is exactly what some people do, especially the first time homebuyers, when shopping for home. They hit the road and start searching for a home of their choice, only for their application for a mortgage to be declined after they have finally located the home they actually like. This can be frustrating. The best way to start shopping for a home is to first get prequalified or preapproved for a mortgage. This will help them avoid some of the frustrations that they may likely encounter in the process of searching for their choice home.

Difference Between Prequalification and preapproval

If you want to buy a home, you will either get prequalified or preapproved for a mortgage before you start shopping for one. What does it mean to get prequalified or preapproved for a mortgage? Is there any difference between prequalification and preapproval? Don’t be too in a hurry; I will explain the two terms to you. To get prequalified for a mortgage, you don’t need to go through the formal process of applying for a mortgage at this stage.  All you need to do in order to get prequalified for a mortgage is to walk up to a bank and discuss your desire to get a mortgage with them. You may not even need to visit the bank. You can call them on phone if you have their contact number. If you don’t know the contact details of the bank, you can quickly go online to conduct some search. Information is just at the tip of your fingers these days. The bank official or representative will ask relevant questions about you. Based on the information you provided, they will be able to advise you on the type of loan you are qualified for, the likely amount you will receive and the applicable rate of interest. You need to understand that prequalification does not constitute any commitment on the part of the bank to grant you a mortgage loan. It is just to give you a fair idea of what to expect so that you will know the kind of property you should be searching for.

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Preapproval on the other hand is more formal. You will need to apply to a bank before you can get preapproved for a mortgage. Instead of you telling the bank about your credit information, the bank itself will conduct its own investigation about you. This will require pulling your credit information. On this note you will need to provide the bank with your Social Security Number. However, you may not need to rush into this as it is not automatic that you will get preapproved for a mortgage if you apply. There are certain things that lenders will look at in order to decide whether to prequalify you or not. Knowing these beforehand will help you decide whether you should not even bother to apply for the mortgage at all. In case you think that you don’t qualify to get preapproved for a mortgage loan, you can start making adjustments in the areas you are somehow deficient. Below are what the lenders will look at in order to decide whether you will be prequalified for the mortgage loan.

• Income: If you don’t earn sufficient regular income that can adequately sustain you, your lifestyle and the needs of your family, it will be difficult to get preapproved for a mortgage. Besides, lenders will like to ascertain that you will have enough money remaining that will be sufficient for your monthly mortgage loan repayment. Lenders will not just rely on the verbal information you supply as in the case of prequalification. You will need to provide evidence of your income. Such evidence will include pay slips covering like six months period, federal tax returns for a three year period, bank statements for your savings and checking accounts and your W-2 statements for two years. Please, the requirements may vary from one lending institution to the other.

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• Savings: You need the evidence of the amount you are having in your savings account. This can also include the money you expect to receive before the mortgage loan will be released to you. It is possible that you worked for somebody who will pay you in the near future time. You will need to provide the bank the evidence of the contract and the acknowledgement from the customer/debtor that he owes the amount and his willingness to pay the amount on or before a specified date. You need enough money that you can use to pay for the down payment, closing costs and the cash reserves that will cover monthly repayments for the next two or three months. A lot of first time homebuyers make the mistake of saving towards the down payment alone. There are various costs that come with mortgage loan at closing. These include loan application fees, points credit/charge, prepaid homeowners’ insurance, an appraisal fee, inspection fees, flood certification fee, transfer taxes, escrow fees, attorney fees and recording fees. Others include prepaid interest, prepaid private mortgage insurance, title insurance, title search costs, credit report fee, cost of obtaining a credit report, processing fees, courier fees and paperwork preparation fees. These closing costs can sum up to about three per cent of the mortgage loan amount. If you don’t have money to pay for closing costs, somebody can pay on your behalf. The person may be your friend or your parent. However, the money should not be a loan which you will need to pay back. It should be a gift. That is, it should not constitute additional loan.
• Debts: Lenders will like to know about other debts you have. Such debts may include car loan, student loans and credit card balances. Lenders will be interested in knowing the percentage of your income that goes into the repayment of your loan. The expression of your debts as a percentage of your income is known as debt to income ratio. This ratio is useful in determining the ability of a customer to pay back the mortgage if granted. The higher the debt to income ratio, the riskier it becomes to lend to such person. If you want to get preapproved for a mortgage loan with ease, it is good to keep your debt to income ratio very low. If your debt to income ratio is already high, it is better you first pay down some of your loans before you apply for a mortgage. Another option is to increase your income level. You can achieve this by taking a second job where possible.
• Employment History: Having a large amount in your bank account does not guarantee that you will get preapproved for a mortgage loan. Lenders like to see that you will be able to sustain your current lifestyle. One of the ways to achieve that is by digging dip into your history of employment. How long have you been working in your current employment? Lenders may not be disposed to giving preapproval to somebody who has just secured a new job. In fact, if you are still in probation, you should not bother to apply for a mortgage loan. Also, freelancers may find it difficult to get preapproved for a mortgage. In most cases, income from freelancing jobs may not be consistent or stable. However, if you work as a freelancer and you have clients that pay you regular fees on a monthly basis, you may qualify for mortgage preapproval. Lenders are more interested in people with stable job.
• Credit score: Your credit score is more than just a three digit figure. Creditors and lenders use credit score to measure customers’ creditworthiness. The higher your credit score; the better your credit rating. If you have excellent credit score, you will find it easier to get preapproved for a mortgage than someone whose credit score is not that good. Credit bureaus use different criteria to calculate your credit score. The criteria used include your payment history, credit utilization, credit age, different types of credit that you have and the number of inquiries made on your account. It is good to mention here that you need to have credit before you can talk about building credit. Some people erroneously think that if they don’t have any credit, that is, if they pay cash for everything they buy that they will have very robust credit score. Credit bureaus need your credit information to calculate your credit score. Without credit, there is no way your credit behaviour can be assessed. There are several ways by which you can build your credit. You can do this by getting a student card or secured credit card. You can also be an authorised user of a credit card whose owner has good credit rating. It is not automatic that having a credit card will help you build credit. If you have gotten your credit card, you need to use the card responsibly. That is the only way you can use your credit card to build your credit. If you want to increase your chance of getting preapproved for a mortgage loan, it can be helpful to apply for your credit report before you apply. This will give you opportunity to review the report for possible errors which might affect your credit score. Correction of such errors may improve your credit score. At times, one or two more points may be what you need to qualify for a mortgage loan.

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• Rent Payment History: If you are a renter, the lender may request that you show your rent payment history for the past two years. You may be asked to provide the contact information of your landlord too. If you are already a landlord, you will provide information about your current real estate holdings.

Why do you need to get preapproved for a mortgage?

Before I forget, I want to let you know that when you apply for a mortgage in order to get preapproved, you might be asked to pay application fee. Nevertheless, it is better to get preapproval for a mortgage before you start shopping around. Below are some of the reasons why getting preapproval is a good idea:

• Loan type: Banks offer different type of mortgage loans. Discussing your situation with your banker will let them know the type of mortgage loan you will qualify to apply for. Apart from the traditional mortgage loans, there are FHA Loans and VA Loans which are usually backed by the government. Your bank may be in a better position to educate you on the type of mortgage loan you should apply for.
• Amount: Having reviewed your credit rating, current income, savings and your current debts, the lender will advise you on the amount you are qualified to receive as a mortgage laon. This will help you know the type and the amount of home you should shop for. You will be able to concentrate your efforts on searching for the home you can afford to buy. It is not that you later discover that your mortgage loan amount will not be enough to pay for a house you like. It will not worth the efforts shopping for a house you don’t have money to buy.
• Interest rate: You should forget about the interest rates that lenders advertise. Lenders usually advertise their best rates and this may not apply to you. Individuals are assessed based on their creditworthiness. When you get preapproved for a mortgage loan, the banker will not only state the amount you are likely to get, you will also be advised on the interest rate that will apply to the mortgage loan. You will be able to assess whether the interest rate is convenient for you or you need to wait till the mortgage interest rates will come down a bit.
• It secures real estate agent’s confidence: You will be to approach real estate agents with confidence and they will be willing to work with you. Having many professionals who are willing to work with you will increase your negotiation power. This means that you can have access to quality and professional services at a good rate.
• Sellers are easily convinced about your readiness: Sellers don’t want to transact business with the people they consider not ready for business. They don’t want somebody who will just waste their time inspecting the property without any intention to buy. That is why some sellers will require mortgage preapproval from homebuyers. If you can show a seller that you have already got preapproval for a mortgage loan amount that is equal or more than the value of the home you want to buy, he will know that you actually mean business. In fact, this alone can make you to be preferred above other homebuyers competing for the same property.

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Conclusion

You need to understand that neither prequalification nor preapproval means that you have been granted the mortgage loan. It is just an expression of willingness of the bank to lend to you. Circumstances may change which may make the lender reduce the amount you have already been preapproved to get. Also, the applicable interest rate may increase. This may happen if your credit score has reduced from where it was when you were preapproved for the mortgage loan initially. While shopping around for a home to buy, it is better you don’t apply for any additional loan. Also, you should not make late payment on your credit card or existing loans. In summary, if you want to ensure that the terms of the preapproved mortgage loan remains the same, you should desist from doing anything that is capable to reducing your credit score.

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