What Does Mortgage Pre-Approval Mean?

For many of us, buying a home represents one of the biggest financial transactions we’ll ever make. While the home buying process might seem intimidating, there are some simple steps that make it easier. One of the most important steps is what’s known as pre-approval.

Pre-approval will help you immensely when you’re searching for a home. It might even give you an edge on the competition once you’re ready to make an offer.  In a competitive market, some sellers won’t even entertain offers from buyers unless they have a pre-approval letter in hand.

pre-approved mortgage is a tentative promise from a lender that it will loan you a certain amount of money for the purchase of real estate, for a certain term and at a certain interest rate. In a pre-approved mortgage process, the lender will base its decision upon your income and credit score.

As a general rule, your housing costs, including your mortgage payment, taxes and heating expenses shouldn’t be more than 32% of your gross household monthly income. This will give you an idea for how much of a mortgage you may be approved.

pre-approved mortgage is a tentative determination by the lender to loan you a certain amount of money. It is not a final decision and is usually only valid for 90 to 120 days. The final decision may depend upon whether the appraisal of the real estate is high enough to protect the lender in the case of default, whether the title is clear, whether the property meets inspection standards, plus a number of other factors.

So what exactly does it mean to be pre-approved for a mortgage?

What Does Pre-approved Mean?

Getting pre-approved is the next step, and it tends to be much more involved. “A pre-qualification should be a good indication of credit and the ability to borrow, but a pre-approval is the definitive word,” says Kaderabek.

Of course, that doesn’t mean you should skip pre-qualification – especially if you’re on the fence about buying or unsure if you’ll be able to qualify for the type of mortgage you want. “One isn’t better than the other, and I suppose the pre-qualification step could be skipped,” says Kaderabek. “But that means a possible premature check on credit, and too many credit inquiries have a negative effect on credit.”

To get pre-approved, you’ll complete an official mortgage application and supply the lender with the necessary documentation to perform an extensive check on your financial background and current credit rating. Some lenders charge an application fee for pre-approval, which typically runs between $300 and $400. After reviewing your finances, the lender can pre-approve you for a mortgage up to a specified amount. You'll also have a better idea of the interest rate you’ll be charged on the loan, and you might be able to lock in an interest rate.

With pre-approval you’ll receive a conditional commitment in writing for an exact loan amount, allowing you to look for a home at or below that price level. Obviously, this puts you at an advantage when dealing with a potential seller, as he or she will know you’re one step closer to getting an actual mortgage.

The other advantage of completing both steps – pre-qualification and pre-approval – before you start to look for a home is that you’ll know in advance how much you can afford. This way you won’t waste time with guessing or looking at properties that are beyond your means. Getting pre-approved for a mortgage also enables you to move quickly when you find the perfect place, and in a competitive market it lets the seller know your offer is serious.

To be pre-approved for a mortgage means that a bank or lender has investigated your credit history and determined that you would be a suitable candidate for a mortgage. (If you want to see where your credit currently stands, the free Credit Report Card grades your credit history on the basics and also provides two free credit scores.) Pre-approvals might only be good for a certain amount of time but they usually signify that a lender is ready and willing to lend you money. It’s a big step in showing sellers that you are serious about buying a house and that your offer should be treated accordingly.

What is a mortgage pre-approval?

Now folks, don’t be fooled: a mortgage pre-approval isn’t a promise that you’ll get a loan for the home you want to buy. A mortgage pre-approval only means a loan officer has looked at your finances—your income, debt, assets, and credit history—and determined how much money you can borrow, how much you could pay per month, and what your interest rate will be.

So, what’s so great about a mortgage pre-approval?

Once a lender has pre-approved you for a mortgage, you’ll get a letter you can then take to sellers. This letter shows sellers you’ve already started working with a lender, and that the lender is willing to work with you. It gives sellers peace of mind to know they won’t be wasting their time with someone who couldn’t afford their house in the first place.

How Mortgage Pre-Approvals Work

Mr. McGillicuddy desires a new house. Before looking at the housing market, Mr. McGillicuddy goes to a mortgage broker completes an application and supplies income and credit information. After reviewing these documents, the broker contacts lenders to determine if Mr. McGillicuddy is eligible. The broker receives offers from several lenders offering to tentatively lend Mr. McGillicuddy $200,000 at 5% interest. They provide a tentative statement that he is “pre-approved” for up to $200,000, based on certain conditions.

Advantages of a Pre-Approved Mortgage

Though it sounds basic, knowing how much you are able to spend before purchasing a home is always a good idea. If you know you are pre-approved for $200,000 and you have $35,000 for a down payment and closing costs, it makes little sense to be shopping for $400,000 houses. With a pre-approved mortgage, you know exactly where you stand before shopping for a home. In fact, many realtors will want to see a pre-approval before they will begin to help you look for a home.

What It Involves

Getting pre-approved is a somewhat lengthy process. But at the end of it all you’ll know whether you can buy a home or not. The process starts before you even find a home. First, you’ll need to go to a lender and complete a mortgage application and provide documents related to your financial history. The bank or lender will then do a thorough investigation into your finances in order to determine how much money they are willing to loan you.

At the end of the pre-approval process, you should be given an exact loan amount. This allows you to look for homes at that price point or lower. At this point, you’ll also have a good idea of the interest rate you’ll be given at the end of the pre-approval process.

The real benefit of getting pre-approved is that when you find a place you’ll be able to move quickly. Once you make an offer, you won’t have to scramble for financing since you’re pre-approved.

Pre-Qualified vs. Pre-Approved

You may have heard the term pre-qualified in the past and assumed that it was the same thing as being pre-approved. Although similar, they are actually two different things. Getting pre-qualified involves sitting down with a lender in order to get an idea of how much money you can borrow. But it is only informational.

You would supply the lender with data such as your income, assets and debts and the lender would give you an idea of how much you can borrow, what type of mortgage options there are, etc. A lot of people make the mistake of thinking that pre-qualified means pre-approved, but this is not the case. Getting pre-qualified doesn’t mean the bank will loan you that amount, but it can give you an idea of how much you can expect to be given once you get pre-approved.

Those who are not sure if they are ready to buy a home may want to get pre-qualified, but it’s not necessary to the mortgage process.

Pre-approved and pre-qualified are not the same thing. It’s important to note that pre-qualification is based on data you submit to a lender, who will provide a ballpark estimate of how much you can borrow. It’s not until you get pre-approved that the lender takes a close look at your financial situation and history to determine how much mortgage you can reasonably afford.

Why would you want a mortgage pre-approval?

While a pre-approval doesn’t guarantee you’ll get a mortgage, being pre-approved does have some advantages. Here are three reasons you might want a mortgage pre-approval:

  1. It gives you confidence in your search. When you know how much mortgage you can afford, you can look for houses within your budget. That way, you won’t have to deal with the heartbreak of falling in love with a house only to discover you can’t afford it.

  2. It puts you on the fast track to closing. Because most of your information is in the lender’s system, a mortgage pre-approval accelerates the loan process once you make an offer.

  3. It establishes your credibility as a homebuyer. A mortgage pre-approval shows home sellers that you have your finances in check, that you’re serious about buying a house, and that you won’t be denied a mortgage if they decide to sell you their home.

Is a mortgage pre-approval the same as pre-qualification?

No! Mortgage pre-approval and pre-qualification are not interchangeable.

The difference is really in the depth of the lender’s research. In order to be pre-qualified, you report your income, debt and assets to your lender, and your lender—without questioning your numbers—tells you, "Based on the numbers you gave us, you may qualify for this much of a mortgage."

But those numbers don’t have to be accurate. If you bent the numbers—if you weren’t precise about your income, your tax returns, or your debt—a pre-qualification will only give you a roughestimate.

A mortgage pre-approval, on the other hand, is a thorough inquiry into your finances. A lender won’t simply ask how much income you make—you’ll have to prove it. Your lender will also pull your credit history, verify your income and assets, and assess your financial situation before they give you a mortgage pre-approval.

4. What do you need to get a mortgage pre-approval?

Since the mortgage pre-approval process is so rigorous, you’ll need to bring a number of documents when you meet with your lender. Here’s what your lender will ask for:

Identification

 Driver’s license or U.S. passport.

 Social Security card or number.

 If you aren’t a U.S. citizen, a copy of the front and back of your green card(s).

 Credit history. Your lender will want to check your credit score.

 Employment verification. Your lender wants to know you have stable employment! They’ll likely call your current employer and ask about your employment and yearly salary.

Income

 Recent pay stubs covering the last 30 days.

 W-2 forms from the last two years.

 Proof of any additional income.

 Last two years of personal federal income tax returns with all pages and schedules.

 Last two years of business federal income tax returns with all pages and schedules.

Assets

 Bank statements that prove you have enough to cover the down payment and closing costs.

 If someone is helping you with the down payment, you will need a gift letter stating that the fund is a gift and not an IOU.

 Last quarterly statements for asset accounts, including your 401(k), IRA, stock accounts, and mutual funds.

5. How long does it take to get pre-approved?

As long as you have all your documents ready, you should be able to get a mortgage pre-approval on the same day you visit your lender.

However, lots of debt, a history of previous foreclosures, and a low credit score can slow down the process. If any of these apply to you, the pre-approval process can be much longer—anywhere from a few days to several months—depending on the complexity of your finances.

The only way to speed up the process is to give your lender all the documents listed above. Don’t forget (or hide) anything!

6. When should you get a mortgage pre-approval?

Any good real estate agent will tell you that getting a pre-approved mortgage is one of the first steps in the home-buying journey. But where exactly does this step fall? Before you even think about going into debt over a house, you should have all of the following taken care of:

 You’re out of debt. You’ve squashed your student loans and kicked that car loan to the curb. You’re debt-free and financially ready to take on a mortgage.

 You have an emergency fund with 3–6 months of expenses. Imagine buying a house and then losing your main source of income. How much would you need to make it 3–6 months while you or your spouse looked for a new job?

 You have a down payment of at least 10%. If you haven’t saved 10%, that’s a good sign you shouldn’t buy a house. Having 10% is the minimum, but a down payment of 20% should be your goal! With 20% you don’t have to pay private mortgage insurance (PMI)—the insurance that protects the lender if your home ends up in foreclosure.

 You’ve agreed to take out a 15-year mortgage. Never—never—take out a mortgage that’s longer than 15 years. Sure, if you take out a 30-year mortgage, your payment may be less every month. But not only will you be in debt for 15 years longer (dumb!), you’ll also end up paying way more than the home is worth in extra interest payments. You could almost buy another house with the money you lose in interest on a 30-year mortgage!

 Your mortgage payments will be no more than 25% of your take-home pay. Any more than 25%, and you’re putting a serious strain on your income, your family, and your retirement.

7. Does the pre-approval expire?

Yes! All mortgage pre-approval letters have an expiration date. Many things can change after you get pre-approved, such as your income, credit history, or even the interest rate. Because of this, your pre-approval normally lasts for 60 to 90 days. When the pre-approval expires, you’ll have to update your paper work to get a new one.

8. Does getting pre-approved commit you to anything?

A pre-approval letter doesn’t bind you to any lender. That being said, if you do decide to take out a mortgage through another lender, you’ll have to repeat the paper work. But if you take out a mortgage through the lender who issued you a mortgage pre-approval, they’ll have your paperwork on file, which will save you time when you’re closing on a house.

9. Do pre-approvals hurt your credit score?

Getting pre-approved for a mortgage—even by multiple lenders at once—won’t hurt your credit score. While it may knock off a few points, it won’t drop your score by a significant amount.

If you pay off your debt and live debt-free, eventually you’ll have no credit score! You might be asking, How will I get pre-approved if I don’t have a credit score?

Don’t worry! You can still buy a home even if you don’t have a credit score. You just need to work with a lender like Churchill Mortgage that still does manual underwriting, a process in which a lender reviews your loan application and determines if they can trust you to repay the loan. 

Now, this doesn’t mean that just anyone can walk out with a home loan using manual underwriting. Specifically, you must:

  • Put at least 20% down on your home.

  • Choose a 15-year, fixed-rate conventional mortgage.

  • Have a strong employment history and personal income to support the loan.

  • Demonstrate 4–6 trade lines that span 18–24 months. These are just regularly recurring expenses such as rent, electric bills, water bills, cell phone bills, etc.

10. Is there anything better than a mortgage pre-approval?

With this competitive housing market, mortgage pre-approval letters have unfortunately started losing their authority. Most buyers have them, and in a multiple-offer situation, they just don’t have what it takes to make you stand out.

But unlike with pre-approved mortgages that only involve a loan officer, your certified homebuyer application is reviewed by a mortgage underwriter—which is a huge advantage when you start shopping for houses! You’ll be able to close faster and have a leg up on other buyers who will probably have to wait for an underwriter to review their application.

References:

[1] Pre-qualified vs. Pre-approved: What’s the Difference? https://www.investopedia.com/articles/basics/07/prequalified-approved.asp

[2] DEFINITION OF A PRE-APPROVED MORTGAGE https://www.firstfoundation.ca/mortgage-glossary/pre-approved-mortgage/

[3] What Is a Mortgage Pre-Approval? https://www.daveramsey.com/blog/mortgage-pre-approval-process

[4] What It Means to Be ‘Pre-Approved’ for a Mortgage https://blog.credit.com/2014/01/what-it-means-to-be-preapproved-for-a-mortgage-72882/

[5] FDIC: Mortgage Loan Prequalifications https://www.fdic.gov/regulations/compliance/mortgage/preq2.pdf

[6] What’s the difference between a prequalification letter and a preapproval letter? https://www.consumerfinance.gov/ask-cfpb/whats-the-difference-between-a-prequalification-letter-and-a-preapproval-letter-en-127/