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Many use the terms pre-qualification and pre-approval interchangeably. While both give some indication of whether or not a potential home buyer can obtain a mortgage for a certain amount, there are significant differences between the two, which are important for a potential home buyer to understand.
Understanding Mortgage Pre-Qualification
A pre-qualification for a mortgage is basically an opinion by a lender, provided as a letter or a certificate, that states that they believe a potential borrower will be able to qualify for a loan. The lender bases their opinion upon credit, employment, income, debt, and asset information provided by the potential borrower. In some cases, the lender will, with the potential borrower's permission, also pull the borrower's credit report. Here's what a typical pre-qualification form might look like.
A pre-qualification opinion is provided on the basis of unverified information provided by the potential borrower. Because of this, it does not guarantee that the borrower will actually obtain a loan. It simply states that it is "likely" that they will be able to obtain a loan should all of the provided information be satisfactorily verified. Obviously, a pre-qualification where the lender is allowed to pull credit is somewhat stronger, but there is still a substantial body of unverified information even if credit has been pulled.
A mortgage pre-qualification letter or certificate will typically state the maximum loan amount for which a borrower would qualify, at a given interest rate, for a given term (e.g., 30 years). It may also state the type of mortgage loan as well (e.g., fixed or adjustable). The letter or certificate will also include a disclaimer stating that this is subject to verification of credit, employment, income, and asset information, as well as a satisfactory property appraisal.
Here's what a typical mortgage pre-approval letter might look like.
Understanding Mortgage Pre-Approval
A pre-approval, on the other hand, is a much more rigorous process. In a pre-approval the same information is requested, but unlike a pre-qualification, the information is verified.
The disclaimers on a pre-approval are typically subject to satisfactory property appraisal and no meaningful changes in the borrower's financial position (for example, loss of job) or market conditions (for example, a sharp rise in interest rates).
A pre-approval may state that the individual is pre-approved for a certain type of loan at a particular rate over a particular term. The pre-approval may also be stated as a monthly payment amount, in which case some work needs to be done to back in to the purchase price of a home.
While a pre-approval is still not a guarantee of a loan, it is much more likely that a pre-approved home shopper will obtain a loan than a pre-qualified home shopper, or an individual who has neither.
Benefits of Pre-Qualification and/or Pre-Approval
There are many benefits to being pre-qualified or pre-approved for a mortgage. The first benefit, and probably the most fundamental benefit, is that the home shopper will know how much they can afford to spend on a house. In addition, many or most realtors will not work with a potential buyer or show them homes unless they are at least pre-qualified for a mortgage. They do not want to waste their own time showing houses that the buyer cannot afford, or going through the whole offer/acceptance process only to find out that the buyer cannot qualify for a loan.
Another major benefit of pre-qualification and pre-approval is that the potential buyer will be in a much stronger negotiating position if they should make an offer on a home. Selling realtors and individuals selling their home take the offer from a potential buyer who is pre-qualified much more seriously than an offer from someone who is not. They would also take the offer of a potential buyer who is pre-approved more seriously than the offer of someone who is simply pre-qualified. In each case, they have a higher degree of confidence that the buyer will be able to obtain the necessary mortgage financing to close the deal.
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