What’s the Difference Between a Prequalification and Preapproval?

The lending process can feel confusing the first time you’re buying a home. For example, you may get a pre-approval from multiple lenders, only to find yourself scrambling to maintain loan approval as you move closer to the close of escrow.

What the heck?!?

Pre-Quals Do Not Equal Loan Approval

The reality is that prequalification is a signifier but not a guarantee that a loan will be approved. This is one reason it’s so important to work with an experienced realtor and use their lender recommendations. Your realtor is there to support every aspect of the home buying process, including providing expert tips on making sure your prequalification manifests in a bona fide loan.

Loan Pre-Qualifications Provide a General Guideline

Prequalification for home loans is based on general premises: 

  • You have a steady income
  • Access to liquid financial accounts
  • Credit debt
  • Credit score 

For the prequalification phase, lenders perform a cursory review of these factors and provide a letter stating a pre-qualified maximum qualifying loan amount. However, they don’t do any work to verify any of the above, nor do they consider other factors. Lenders know that anything can change after they’ve provided that initial pre-qual letter, so they have no obligation to hold to that amount in the long term.

Your real estate agent uses the prequalification letter to determine which houses are within your price range and, therefore, worth touring. 

Pre-Approval is the Next Step 

Loan pre-approval is the next step in the funding process. Now that you’re seriously house hunting and ready to make offers on prospective homes, the lender must perform stricter due diligence to verify the prequalification factors you reported during the initial prequalification process.

To gain officiant “pre-approval,” home buyers must provide documents and proof of their financial status. This includes:

  • An official mortgage application
  • Proof of income
  • Tax documents (often for the past three to five years)
  • All financial accounts with current balances
  • Current debts/payment history
  • Updated credit report

Because the lender verifies these factors, loan pre-approvals typically carry more weight when buying a home. And, in a seller’s market, there’s a good chance the seller’s agent will only consider offers from buyers with genuine loan pre-approval.

Five Things You Can Do to Support Your Loan Funding

Here’s the sticky part; a loan pre-approval is still not considered a guarantee that the lender will fund the loan. This is why the buyer’s actions are so crucial for the weeks and months leading up to buying a home.

There are five things you can do when buying a home to ensure your loan prequalification and pre-approval transform into genuine loan funding:

1. Make all payments on time

Your credit score and credit report play a significant role in the loan approval process. A credit score tells lenders what kind of borrower you are:

  • 300 – 579: Poor
  • 580 – 669: Fair
  • 670 – 739: Good
  • 740 – 799: Very Good
  • 800 – 850: Exceptional

The credit report contains seven to ten years’ worth of your credit history, including open accounts, closed accounts, late payments, collections, and so on. Lenders use all that information to determine whether borrowers are trustworthy enough to pay their loan back on time. 

Your credit score also affects other important aspects of a home loan. Higher credit scores often translate to lower interest rates, which may help you to earn “lender points” or other lender incentives that lower the homebuyer’s final closing costs.

2. Pay down as much debt as possible

Can you make extra car payments or credit card payments to eliminate debt? The more debt-free you are, the better you look to lenders. If at all possible, pay off your credit cards each and every month (and resist the urge to spend more than you earn) to keep your credit-to-debt ratio as favorable on the credit side as possible.

3. Don’t take out any new loans

Now is not the time to buy a new car or use a credit card to purchase a big-ticket item. We have had clients have lender underwriters kick back a loan because they bought a new car between the loan approval process and the close of escrow. Underwriters run credit reports right before funding a loan to make sure you still qualify. If your financial landscape has altered (lower score, missed payments, new loans that negatively impact your credit-to-debt ratio, etc.), they have the right to pull out on the funding.

4. Season your gift money for at least two months

It is not uncommon for family members to give their loved ones gift money towards the down payment. To count gift money towards loan approval, it needs to be deposited into the home buyer’s account at least two months prior to funding. Once money has remained in the account for two months or more, it’s called “seasoned money,” and lenders consider it legitimate. 

If your parents or grandparents are contributing towards your home’s down payment, they need to write the check or wire the money to you at least ten weeks before funding to ensure it’s seasoned enough for the lender’s comfort.

5. Be prepared to claim gift money exceeding $16,000

If you are the beneficiary of downpayment gift money, make sure you understand the IRS tax laws. Currently, any gift money exceeding $16,000 per year must be claimed on your taxes. This can be an unexpected “uh-oh” moment in a year where mortgage expenses, remodels/renovations, or new home furnishings depleted the coffers. Meet with a financial advisor to ensure you have enough set aside for potential tax-associated fees.

Southern Exclusive Realty is Here to Help

The team at Southern Exclusive Realty has close relationships with several high-quality lenders in the area. If you’re anticipating buying a home, now is the time to establish partnerships with local real estate experts and lenders to ensure you do everything right to keep your home loan approved and moving forward. Contact us to get started. 386-279-7244.