Understanding the difference between pre-qualification and pre-approval is particularly important as a home seller so that you are prepared to assess the strength of offers that come in while you are selling your home. When a mortgage will be used to purchase your home, there are conditions that need to be met for the mortgage company to approve the purchase for closing. Because final clear to close determination comes well down the road, it represents a certain amount of risk that the deal will close. This article shares a little more insight to help you better understand exactly how much value these bank letters provide.
Many people think that a PreApproval goes a step or two further than a Pre-Qualification and that it is more "secure." However, until we know what actually goes into either one, both are just vague terms that carry more assumed weight than they should.
To start our discussion, it's important to know the difference between :
- Pre-Approval and/or Pre-Qualification
- Full Mortgage Application
- Loan Commitment
PreApprovals (PAs) and Pre-Qualifications (PQs) are preliminary estimates of mortgage affordability based on information a buyer has provided to the lender. They are neither offers to lend, nor agreements to borrow.
By definition and function, they are prepared before buyers submit an offer on a specific property making them initial estimates of affordability. Some Mortgage Originators readily provide PAs and PQs before thoroughly evaluating a buyer/borrower's true financial picture. This can also be seen with PreApprovals generated from online lender sites. Unfortunately, this can create false confidence in buyers and sellers.
A thorough and dependable PreApproval contains most of the elements needed to turn into a supported Application when a purchase contract is accepted. According to the CFPB (Consumer Financial Protection Bureau), the Federal Agency that oversees all things mortgage-related, borrowers have made loan Application when they have provided just the following 6 pieces of information:
1 - Name(s)
2 - Income
3 - Social Security number (to obtain credit report)
4 - Property value (estimate, not yet an appraisal)
5 - Loan amount sought
6 - Specific property address
Note that none of these items necessarily has to be verified in order for someone to have made a legal application and receive mandatory initial disclosures. The property address is usually what turns a loan inquiry into a loan Application, causing the borrower to receive CFPB-required disclosures before continuing. Therefore, a buyer can now comply with the purchase contract's Financing Contingency requirement to make timely mortgage
application, yet not have provided any supporting documentation.
Before sending an Application to Underwriting departments, lenders must still ask for and receive followup information to support anything that's in the Application. This can include tax returns, bank statements, employment verifications, letters of explanation, and anything else needed to verify what's been submitted. At this point, further progress depends entirely on how quickly the buyers submit their documents.
Only after the full Application is submitted to Underwriting and it looks good for final Approval, can a Mortgage Commitment be made by the lender. At Underwriting, buyer, property, and contract details are checked for compliance with specific loan program guidelines.
A Mortgage Commitment (or denial) is the only document that provides buyers with enough information to decide whether to continue on toward closing, or fall back the Financing Contingency and terminate the deal. Remember that the contract specifies the date on which the contingency expires, ending those buyer options. Even then, there are still conditions to be met before closing. Almost all Mortgage Commitment have conditions, which may include requests such as:
- Proof of homeowners insurance
- Most recent bank statement showing money for closing costs
- Financial statements from the property's HOA
- Pre-closing refreshed credit report showing no new debts
- Evidence of clear title and lenders title insurance
- Letters of explanation for items questioned by Underwriting
Not meeting all conditions will prevent the buyer from receiving final Approval and a Clear-To-Close (the last step before closing and funding). If the buyer's Loan Originator didn't think ahead to possible closing conditions (based on a buyer's true financial picture) when doing a PQ or PA, the deal could still fall apart after everyone has spent 4 or 5 weeks waiting for closing.
Here's are things to look for in a PreApproval:
Date prepared and name of lender
Down payment (amount or %) and loan term (30 years, etc)
Occupancy (primary, second home, investment)
Type of loan (conventional, FHA, VA, USDA)
Loan or file identification number
Name and contacts of person who prepared it
Make sure ALL the above items are included, then contact the mortgage contact who prepared it and ask :
Have available funds for down payment and closing costs been verified?
Do the buyers qualify for any other loan programs than the one indicated on the PA? (Your "Plan B", if needed)
Has this file received initial processing and preliminary Underwriting review?
Have you allowed for property taxes, home-wind-flood insurance, and any HOA/condo fees and dues? If so, how much?
Knowing how to read and respond to a PreApproval or pre-qual letter can save you significant time and effort on your next financed deal. Well-informed buyers and sellers make transactions so much smoother.