Guest Contribution from Michael Eastham, CPA
Certified Residential Mortgage Specialist &
Chief Executive Officer - Global Lending Group
Phone: 407-388-1036 (ext. 140) / firstname.lastname@example.org
140 N. Westmonte Dr #204 - Altamonte Springs, FL 32714
In the world of real estate transactions, professionals and purchasers sometimes use the words “prequalification” and “preapproval” interchangeably. The problem is they mean two totally different things. If you are using the wrong word in place of the correct word, you may find yourself in the throes of a very sticky situation.
Let me paint the picture for you: you are the potential buyer of a home, ready to make an offer on a house. Your realtor tells you that you need to get a “pre-qual” letter from your lender to submit with the contract. You receive the letter and give it to your realtor. The letter is then submitted with the contract and accepted by the seller. Great news! Or is it? The contract states that you must close within 30 days and you could not be more excited. Now, let’s fast-forward to day 28. Your lender calls you to let you know that your loan was declined.
How could something like that happen, you ask? You were pre-qualified! Well, this is one of those times when you must understand what the definition of “is” is. There are significant differences between being prequalified and being preapproved. Knowing what they are beforehand can determine whether you actually close on the transaction or not.
Having a pre-qualification simply means that you have had a conversation with a lender and based on the information you have submitted, (and assuming all of it is true and that you can document it) the lender believes that you will get the loan. This is a very simple thing to do. In a 10-minute conversation, I can determine a borrower’s debt-to-income ratio, credit score, amount of available assets, and what loan to value is needed for the borrower. However, one thing that is not included in this process is the documentation needed to support the loan request. Without this information, the lender runs the risk that any one of a hundred variables could shoot down the loan and it could be declined.
When you get preapproved, it means that your lender has not only reviewed your loan information as in the prequalification stage, but has also taken that loan through several other steps to insure loan commitment. All of the pertinent documentation to support the loan request has been collected and reviewed by the lender. This is called the credit underwriting stage, and it is critical to make sure that the borrower is credit approved. W-2’s, pay stubs and tax returns are reviewed in order to verify income. Employment is verified. Funds necessary for closing and post closing reserves are sourced using bank statements, investment statements, and retirement assets. The credit report is carefully reviewed and prior mortgage history is verified. All compensating factors are considered as the underwriter assures the lender that the documentation supports the loan request in accordance with the guidelines for the requested loan program.
Once the credit underwriting is completed, we are able to issue the “preapproval” letter that states the loan is approved, based on the credit worthiness of the borrower. The only unknown factors are those relating to the property. That is why this credit approval will always be subject to the borrower providing a fully executed contract and a satisfactory appraisal for the subject property. This is a significant point, because when buyers have been preapproved, they are for all intents and purposes, the equivalent of a cash buyer. They are typically in a much better negotiating position, and are much more likely to have their contract accepted by the seller.
If you are serious about getting the house you want, you must understand the difference between these two terms. It is important to have that “preapproval” when you submit the contract. That way you can submit your offer with confidence, knowing that the loan is ready to go as soon as you get the contract and the appraisal. Of course this takes a little more time, but that is where a little planning comes in. If you get started just a few weeks before you plan to go house hunting, I guarantee it will save an enormous amount of time, pressure, and anxiety on everybody’s part when you do find that “home of your dreams.”