Getting Pre-Approved for a Home Loan vs. Being Pre-Qualified
What’s the difference?
There is no greater misunderstood term in Real Estate than the loan “Pre-Approval.” (See our previous post on Reasons Why Your Preapproval Might Be A Lie)
In some cases, this is a just a question of semantics as many loan officers will use one term to grade a wide range of confidence in the loan decision being given.
Call it attention to details if you like, but I think there needs to be a clear distinction between being pre-approved and pre-qualified.
There is no minimum standard criteria for what is a Pre-Approval and what is a Pre-Qualification, other than what individual loan officers and lenders choose as a definition. The way we look at it, there is actually a huge difference.
Knowing with a high degree of certainty that you are approved for a home loan is what most sellers are looking for before you submit a purchase offer. A Pre-Approval typically means that your loan application, credit scores, credit profile, income & assets have been reviewed by an underwriter, or person with similar experience and scrutiny.
All of these documents are then reviewed and uploaded into an automated underwriting engine (like Fannie Mae DO/DU) and an underwriting decision is made and documented. You should receive a printed loan approval by a recognized automated underwriting engine for these findings to be valid.
The “Pre” part of the approval process refers to the fact that there is not yet a property related to the underwriting approval. Many times the documentation required for the approval (pay stubs, assets, W2’s) need to be updated by the time you find the right property and have your offer to purchase accepted.
Final approval for financing will be determined once the purchase contract, inspections, appraisal and all conditions required by the lender are received and approved. This is what you are looking for to remove your financing contingency, which usually occurs in the first 10 to 17 days of escrow being open.
I want to preface this by saying that my definition of a Pre-Qualification, while widely accepted, is not necessarily the only way to define this particular stage of the approval process.
Pre-Qualification often refers to a rough idea from the loan officer or broker, based on a verbal interview or preliminary review of a home buyer’s credit, income and assets. Anything less than a Pre-Approval is not usually accepted by the seller of the home.
If you are Pre-Qualified for a home loan by your lender, you should now have enough information to decide whether or not you are going to go through with the loan process.
After you are Pre-Qualified, the next step is to gather all of the required documents necessary to ensure an accurate approval, with an Automated Underwriting System Approve/Eligible to show for it.
Pre-Approval and Pre-Qualification Letter
Before making offers on a home for sale, you’ll have to provide a pre-approval package along with your purchase offer. It is impossible to overstate the importance of having a Pre-Approval, backed up by an application, credit report and documentation to support income and assets.
The biggest difference between a Pre-Approval and Pre-Qualification is going to be the confidence level the loan officer has in the information you’ve provided.
A good loan officer with many year’s of experience can often do a pretty good job of identifying any challenges that may prevent a Pre-Approval. Most times it’s simply a matter of digging up all of the required documents one time.
A strong Pre-Approval package typically includes a letter from a lender stating your credit-worthiness, accompanied by the front page of an Automated Underwriting System decision (AUS). This is typically a Fannie Mae DO or DU approval.
A DO or DU can be produced based on any data your lender inputs into the system. It is possible for you to get an AUS approval based on information that has not been received or reviewed.
It’s a serious red flag for a lender to provide you with a loan approval without you first providing the below list of items for review by the lender. Any loan officer willing to give you a Pre-Approval without you first providing these items, is willing to gamble with your ability to actually qualify for the home you’re trying to buy.
I’ve seen too many horror stories from folks that were lied to about being pre-approved, when in fact they were not.
Documents Needed for a High Confidence Pre-Approval
Here’s a quick list of the most important documents you will need to provide before your loan approval can be considered a High Confidence Pre-Approval:
- 2 Years W2s – all borrowers
- 2 Years Tax Returns if you itemize (not necessary if you are W2 & file 1040EZ)
- 3 Years Tax Returns if you are applying for Down Payment Assistance
- Last 30 days pay stubs – all borrowers
- Last 60 days asset statements – checking, savings, 401k, CDs, retirement
- Clear copy of Drivers License or other acceptable Photo Identification
- Clear copy of Social Security card
- Authorization to process Verification of Employment & IRS form 4506T
3 Scenarios that Can Cause Delays
It is important that you head these types of scenarios off early in the process so that you don’t encounter them later down the road, or worse, during escrow after you have an accepted contract.
1. Self Employed – There are still challenges for those that have realized the first part of the American Dream, the self employed. If you are self employed, or own more than 25% of a LLC, Corporation or any other business entity from which you are claiming income or losses, qualifying can get challenging if your tax goal for the past two years has been to pay as little as possible.
2. Bonus & Overtime – In order to use bonus and overtime income to qualify for a home loan, you have to show a history of receiving bonus or overtime pay, and verify probability of continuance on a Verification of Employment (VOE) that is completed by your employer.
3. Gift Funds – When gift funds are being used for the purchase of a home, it is vitally important that you inform your loan officer early in the process. The improper receipt or documentation of gift funds can cause major delays.
Communication is Key
The bottom line here is that communication between you, your agent, and your loan officer is the best way to avoid headaches during the escrow process. Don’t be afraid to ask lots of questions, and never just take your loan officer’s word for it if something doesn’t sound quite right.
Good communication, and a sound understanding of the process will make your transaction go much smoother once your offer is accepted.