Prequalification vs Preapproval

What’s Your Buying Power?

We all love to browse through the multi-million dollar listings and dream about “what if”. Which is a fun way to pass the time, but when you’re seriously looking to purchase a home, you’ll need to find out your “buying power”.

What does that mean? Essentially, how much you can borrow based mostly on your income, assets, liabilities, and credit. Unless you’re paying cash, in which case kudos to you. And call me ­čÖé

Assuming you need to finance your purchase, then you need to speak with someone who’s in the business of lending money. That’s when it gets tricky because there are a gazillion banks, web sites, mortgage brokers, etc. And you’ll probably get different information from them.

Prequalification vs Preapproval

One major difference you need to be aware of is how lenders determine your buying power. Some will give you a prequalification letter stating what you could borrow while others will issue a preapproval. And they’re not the same thing.

A prequalification is based on your self-reported income, credit score, etc. You may enter these online or give them to a person over the phone. Then an algorithm spits out a number in a few seconds. But this information is completely unverified. Would you lend someone hundreds of thousands in this case? Well, that’s what many banks did a decade ago and we all know how that ended.

So a prequalification letter isn’t worth the paper it’s printed on. No serious listing agent will consider this an adequate proof of your borrowing capacity. After all, they want to be reasonably assured the transaction will go to closing.

On the other hand, a preapproval is a lot more involved. After collecting the relevant information from you, the lender will:

  • Run your credit report and obtain a credit score;
  • Verify your employment status by calling the HR department;
  • Ask for copies of your bank statements, stock brokerage accounts, 401(K), etc. to verify assets;
  • Ask for a copy of your most recent tax return;
  • Possibly do more in case you have rental properties, your parents will gift you some money towards a downpayment, etc.

The whole process will take a few days. Keep in mind that you shouldn’t be charged anything for a preapproval letter.

Having a preapproval letter in your hand is good for two reasons. One, the listing agent knows your information has been verified. Two, you’ve probably been able to identify any red flags on your credit report (or elsewhere) and taken steps to address them. Otherwise you could end up in deep trouble a week or two before closing.

Another common pitfall to consider is that not all income is counted the same towards your qualification. Bonuses, commission and some benefits often are disregarded because they may not be consistent from year to year. A website may not catch this, but an experienced lender most certainly will.

Ready to Roll?

Hopefully this post helped clarify this important first step. You may want to check out my post on the process of choosing a house.

And if you’d like further guidance or just need to ask a question, don’t hesitate to contact me:

3 Comments
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