Many homebuyers are confused by the terms "pre-qualification" and "pre-approval." A "pre-qualification" is simply a quick conversation with a mortgage loan officer, usually over the telephone, to determine how large a mortgage amount you can afford based on your current income and debt situation. The loan officer takes the numbers you give him or her and uses a calculator or computer program to calculate an approximate maximum loan amount based on the current interest rates for various loan programs. That gives you a realistic idea of how much home you can afford to spend on a house.
A "pre-qualification" is just the first step in the mortgage application process. It is not a guarantee that you will get the loan, it just means that you can qualify for a certain loan amount IF your income and credit report checks out as stated. However, that is not always the case. You may have overestimated your actual income, or more commonly, you may have underestimated your monthly debt payments or your credit rating may not be as good as you thought.
The only way to know for sure that you will get the loan amount that you want is to get "pre-approved" for a mortgage. That means filling out the loan application form and providing all the required documentation to prove your stated income and financial assets, such as paycheck stubs, bank account statements and investment statements.
The most important factor in qualifying for a mortgage is your credit score, commonly called a "FICO score." The only way to truly know what your credit score is for mortgage purposes is to have your credit report pulled by a bank or mortgage company. The credit scores that you get from those "free credit report" services are not the same as a mortgage credit score because they use a different computer algorithm to score your credit.
After pulling your credit report, the mortgage company will run your loan application through a computerized automated underwriting system to get a loan approval based on your income, credit and financial assets on your loan application.
After receiving an automated loan approval, which takes only a few seconds to process after submitting a completed loan application form, the bank or mortgage company gathers the paycheck stubs, bank statements and other documents required by the automated loan approval findings.
Your complete loan file is then reviewed and approved by a human underwriter to make sure it meets the lender's guidelines for the loan program for which you are applying. If everything is in order, you will receive a "credit approval" on the loan. That means you have a written loan commitment based on your income and credit and all you need is a house to go with it.
You can then get a "pre-approval letter" from your mortgage company or bank that your real estate agent can use when making an offer on a home. Home sellers and real estate agents love to work with homebuyers who have been pre-approved for a mortgage. They will take you more seriously when you make an offer, and you will have more bargaining power because you can guarantee that your offer will close. It's the next best thing to being an all-cash buyer. Home sales sometimes "flip" when the buyers fail to qualify for a loan and the seller is forced to put the house back on the market. By relieving the sellers of that anxiety in advance, you may be able to drive a tougher bargain on the purchase price because the sellers know you can close quickly.
So if you are shopping for a home, fill out a loan application as soon as possible and get pre-approved. I know that filling out forms isn't a lot of fun, but it is much easier to complete the loan application process while you are calm and relaxed, rather than stressing out over a purchase offer that you just made on your "dream home." There is plenty of pressure involved in negotiating the purchase of a home without adding the stress of applying for a mortgage at the same time.
Steve Tytler is a licensed real estate broker and owner of Best Mortgage. You can email him at firstname.lastname@example.org.