Mortgage Pre-Approval vs. Pre-Qualification: What's the Difference?
Matthew Frankel, CFP, The Motley Fool
Updated
These two terms are often used interchangeably, but have very different meanings.
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The terms pre-approval and pre-qualification are often used interchangeably, both by homebuyers and by some real estate professionals. However, they have completely different meanings and it’s important to know the difference.
In a nutshell, a mortgage pre-qualification generally occurs when you fill out some basic information in order to obtain a rate quote. It is often a quick and informal process, and different lenders have different methods of pre-qualifying borrowers. The key point is that it does not represent an actual commitment to lend you money. Meanwhile, a mortgage pre-approval is a lengthy and thorough process, and having a pre-approval letter in your hand can carry a lot of weight when you’re shopping for a home.
Pre-qualification is quick and easy, but doesn’t carry much weight
The most important thing to know about pre-qualification, from the perspective of both buyers and sellers, is that just about anyone can get a pre-qualification for a mortgage.
Why? Anyone can get a pre-qualification because the pre-qualification process is often based on information that you provide. It may include a credit check, the lender doesn’t usually call your employer or review your actual pay stubs or W-2s during a pre-qualification, and they won’t confirm your assets.
To be fair, some lenders do a more thorough pre-qualification. They may do a credit pull as part of the pre-qualification process, for example. However, in many cases, pre-qualification is based on self-reported information about your credit, income, employment, and assets. For example, U.S. Bank uses pre-qualification to determine if a borrower’s debt-to-income ratio is within its lending standards but doesn’t examine detailed information about the borrower, nor does it include a credit check.
This isn’t to say that a pre-qualification isn’t useful. Quite the opposite, actually. A pre-qualification can be a great way to get an idea of how much you can afford to borrow and is an excellent first step before you start browsing real estate listings. Just remember that a pre-qualification typically isn’t a commitment to lend you money.
Pre-approval can be a lengthy and more thorough process
A mortgage pre-approval is a thorough process. The lender will check your credit, and may verify your employment history, income, and other assets. In short, the pre-approval process is a mortgage application, only without a specific home attached to the application.
While a pre-qualification is generally based on self-reported and unverified information, a pre-approval is not. Here’s a sampling of what you may need to submit to a lender (in addition to an application packet) in order to obtain a pre-approval, but this is by no means an exhaustive list:
Your residential address(es) for the past two years, along with information about your landlords if applicable
Bank statements for all checking, savings, and brokerage accounts
Your pay stubs from the past 30 days
Your past two years W-2s
Your Social Security number, so the lender can pull your credit report and score
Here's the key point: A pre-approval represents a commitment from the lender to loan you money.
Once you are pre-approved for a mortgage, the lender will give you a document known as a pre-approval letter. This gives information about the lender, the loan program for which you’ve been approved (FHA, conventional, etc.), as well as the maximum amount of money they are willing to lend you.
A pre-approval can help you tremendously as a prospective buyer
Your pre-approval letter can be one of the most important shopping tools you bring with you when shopping for a home. Simply put, it tells sellers that you are a serious buyer and can actually buy their home for the amount of money you’re offering.
Think of it this way. Let’s say that a seller is asking $200,000 for their home and two offers come in. One is for $190,000 with a $1,000 earnest money check attached to the offer document. The other is for the exact same amount, with the exact same earnest deposit, but has a pre-approval letter attached to it from a reputable lender. Which do you think is likely to be taken more seriously?
It’s not even uncommon for sellers to accept the lower of two offers because it has a higher probability of closing. Sellers don’t want to have to deal with the hassle of waiting for buyers to secure financing, and the last thing a seller wants to do is to take their home off the market for a month or longer, only to have to re-list it because a buyer couldn’t get approved for a mortgage. In fact, some sellers won’t even entertain offers that don’t have pre-approval letters accompanying them.
While a pre-approval letter doesn’t exactly give you the offer strength of a cash buyer -- there is still a chance you won’t be able to get a mortgage, even if you’re pre-approved -- it is the next-best thing.
It’s also important to mention that you can typically request a pre-approval letter for less than your full-approved amount. Think about it -- if you want to offer $250,000 for a home, you probably don’t want the seller to know that you’ve been approved for $300,000. On the other hand, if the letter says that you’ve been pre-approved for $250,000, that’s the top of your budget, as far as the seller is concerned. Most lenders are happy to do this, and this can actually be a rather effective component of your negotiating strategy.
A pre-approval is an optional, but important, part of the home buying process
To be clear, you don’t need to obtain a mortgage pre-approval in order to start shopping for a home. A real estate professional will be happy to start showing you some homes and submit offers on your behalf without a pre-approval in your hand.
However, obtaining a pre-approval is a smart idea for two main reasons. For one thing, it lets you know beyond any reasonable doubt that you’ll be able to obtain a mortgage, and how much you’ll be able to borrow based on your actual financial situation. Additionally, a pre-approval shows sellers that you are a serious buyer and will be able to close on the home at the price you’ve agreed to pay. So, while you don‘t need one, it’s definitely a good idea to get pre-approved before you submit your first offer on a home.
Obtaining multiple pre-approvals is even better
As a final thought, while a pre-approval is certainly an excellent tool to have, one pre-approval might not be enough. It may be a smart idea to apply to a few mortgage lenders to see which one offers you the best deal.
Here’s what I mean. When you obtain a pre-approval, the lender will also tell you the interest rate you’ll get. And, you might be shocked at how much of a difference seemingly small differences in the interest you’re paying can make over the long run. For example, if you’re obtaining a $250,000 30-year fixed-rate mortgage, the difference between a 4.75% interest rate and 4.80% is nearly $2,900 in savings over the term of the loan.
Even if two banks offer you the same interest rate, the fees they charge for originating, underwriting, and processing your loan can vary significantly.
Furthermore, applying to a few different mortgage lenders won’t hurt your credit score. There’s a special rule in the FICO credit scoring formula that encourages rate-shopping. Specifically, any mortgage applications you make within a “normal shopping period” -- which is generally defined as two weeks -- will count as a single credit inquiry for scoring purposes. In other words, whether you apply for pre-approval with one, two, five, or 30 mortgage lenders, it will have the exact same impact on your credit score. Now, I’m not saying that anyone needs to apply to 30 lenders, but you get the point.
The bottom line is that shopping around during your pre-approval process can be an extremely smart move. You don’t have anything to lose, except maybe a few hours of your time, and doing so could literally save you thousands of dollars.
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