Pre-Qualification vs. Pre-Approval

Understanding How Much Home You Can Afford in Order to Plan For that Dream Purchase

By

Matt Lyons

on

Jan 21, 2021

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If you’re in the process of looking to buy a home, you’ve probably come across the terms “pre-qualification” and “pre-approval” when seeking a mortgage loan. What exactly do these things mean? Oftentimes the two terms are used interchangeably or even get confused for each other, so it’s important to understand the differences before you move forward. A pre-qualification is a bit of a less in depth process than a pre-approval, with a different verification process used to determine how much you qualify for. 

Mortgage Pre-Qualification 

Pre-qualification is one of the first steps you can take in the homebuying process. You will provide a few financial details to your mortgage lender, which might also include a soft credit inquiry. Your lender will then give you an estimate of how much you’ll be able to borrow, along with interest rates you qualify for. 

A prequalification is a great way to give someone insight into how much they could expect to borrow. You can also get a better idea on some of the different loan programs, and how monthly payments would stack up. Because the information you provide to a lender is not completely verified through a prequalification, you can not expect a guarantee of the mortgage amount  approved. It might be beneficial to try and get verified from a couple different lenders, so that you’ll be able to compare various interest rates and monthly payments.

Prequalification + Credit Score

Preview of Experian
Credit bureaus like Experian allow you to check your credit at no cost. Image courtesy of Experian

Most times, mortgage lenders will conduct a soft credit inquiry to catch a glimpse into where your credit standing is. If you’re looking to get prequalified from a lender, it’s important to check how they run the prequalification process, and if a regular credit check is involved. Most credit checks are counted as one inquiry on your credit report, which can have an impact on your credit overall. 

If you’re worried about your current credit standing, it might be best to avoid the mortgage lenders who conduct the credit checks. Overall, getting a prequalification earlier on in the homebuying process can give you more time to work on credit standing and try and qualify for a bigger loan, or one with a better interest rate. The prequalification process is also rather quick, usually online or by the phone. 

What If I Don’t Qualify for Pre-Qualification?

More often than not you can expect to get prequalified from at least one mortgage lender, but there are times where prequalification will not be approved. If you happen to run into the problem of not prequalifying, there are several things to work on to help improve your chances:

  • Make a plan to tackle some of your debt
  • Save for a bigger down payment
  • Improve your credit score
  • Look over your credit report for errors
  • Consider a better position at your job or find another way to increase your income 

Mortgage Pre-Approval

In order to take a further step into being approved for a mortgage loan, pre-approval is a more in depth process that helps give you a better idea of where you stand. Pre-approval consists of verifications to help approve you for a mortgage loan. Lenders will conduct a more thorough credit check, verify your employment, and look through various financial documentations. These documentations may include pay stubs, bank statements, and tax returns. 

A pre-approval will ultimately allow lenders to determine your debt-to-income ratio (DTI). Your DTI is your monthly debt payments divided by gross monthly income. A DTI is one way lenders can measure your ability to manage those monthly payments to repay the money borrowed. If you’re interested, you can easily calculate your DTI on your own by just adding up all your monthly debt payments and dividing them by your gross monthly income. This can give you an insight into how the preapproval process might turn out when it’s time.

  • For example, let’s say that you pay $1500 a month for your mortgage and another $100 a month for an auto loan. You are also paying $400 a month for the rest of your debts, so that means your monthly debt payments will come to a total of $2,000.
  • If your gross monthly income is $6,000, then you will take 33% of $6,000 to get $2,000. 

Along with the DTI, lenders will give you an itemized estimate of interest rates, closing costs, monthly payments, and the maximum amount you’re approved to buy. Once you receive a pre-approval, you’ll be a fully approved buyer! When the time comes to buy a home and get your mortgage, the lender only needs to approve the property you’re buying before issuing the full mortgage approval. 

Why Is It Important to Get Pre-Approved?

A mortgage pre-approval ensures that you are able to take on the mortgage payments. A mortgage approval will also let the sellers of the home you wish to buy know that you can afford the home. This will help to increase the chances of locking down that offer on your dream home!

Taking the Best Course of Action

Overall, determining how much of a mortgage you can qualify for through pre-qualification is a great choice for potential homebuyers starting out. Once you have gotten to the point in the process where you’re ready to make an offer on a home, a pre-approval will show that your finances and creditworthiness are verified.

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