There is a lot of confusion surrounding the difference between a mortgage pre-approval and a pre-qualification. While both are related to the amount of money you can expect to secure for a mortgage loan, there are some distinct differences between them.
Here’s what potential buyers should know before setting out in search of their dream home:
What is pre-qualification?
Pre-qualification is the first step in the mortgage approval process. It is essentially an educated guess that lenders make as to what you can realistically afford. They use a simple algorithm based on your overall financial picture (income, savings, assets and debts) to provide you with a rough number of what you can expect to be offered. It can usually be done over the phone or online and there is no cost associated with this service.
The problem is that a pre-qualification isn’t an official document and many home buyers take it at face value, beginning their search with only an estimated dollar amount in mind. In many cases, this leads to heartbreak when people finally find their dream home and their financing comes up short. Talk about crushing, right?
What is pre-approval?
That is exactly why it’s important for home buyers to seek pre-approval. This process is a lot more detailed and offers you a firm number on what a lender is able to offer you. With a mortgage pre-approval, your search becomes a lot easier and you can make a decision with a greater sense of confidence. Buying a home is not a small purchase and comes with a lot of stress as is – so with a realistic picture of what you can afford, you can approach your home buying decision with a clear head.
So now you’re probably wondering how the pre-approval process works. Well, the lender will perform a credit check, confirm how much you earn, determine your financial assets, investments and savings and factor in any existing debts. You will then be asked to provide bank statements and paystubs. The lender will also order a credit report to check your credit rating and compare your documentation against existing requirements. You’ll be pre-approved for the loan based on whether or not you reach these qualifications.
Advantages to getting pre-approved
A sizeable down payment will also have a positive effect on the amount you’re pre-approved for. Avoid making expensive purchases before you go through the pre-approval process and keep in mind that you will need to have additional funds in hand for closing costs and other unexpected expenses that come along with buying a home.
One other bonus that comes along with having a pre-approval is that many sellers see this as a sign that you are serious about buying. It basically tells the seller that there will be no headaches and financial issues when it comes to completing the sale and the transfer of home ownership. You essentially have the paperwork to prove that you are ready to pay immediately.
Pre-approvals: Potential pitchforks in the road to home ownership
One thing to remember is that while a pre-approval is a pretty safe bet that you will be able to secure financing, there are still some factors that could throw a wrench into things. The results of a home appraisal or insurance and titling could affect the final dollar amount, so until the lender has reviewed the home you decide to buy it’s best to err on the side of caution when maxing out your budget.
Another thing to keep in mind is that pre-approvals are only valid for two to four months, so make sure you’re ready to start shopping within the coming months or you will have to repeat the process all over again. The reason for this is that the lender will want to revisit your financial situation at that time to make adjustments based on any changes. This is another reason to be on your best behaviour financially throughout the home buying process.
Going down the home stretch
Once you have received pre-approval, the next step is a loan commitment. This is the green light that the lender has approved both you and your future home. In this step, the home must be appraised at or above the sale price. Should the home inspector or appraiser find any issues with the home (structural, outstanding liens), the process will be delayed. This will not negatively affect your chances of being pre-approved again.
If there are no issues with the home, the lender double checks your portfolio to ensure your financial situation has not changed since the pre-approval and then you are good to go ahead and sign on the dotted line.
For more information on your burning mortgage questions and how to find the right mortgage for your needs, visit our Mortgages 101 page.