One of the very first steps you should take as a home buyer is to speak with a lender to determine your buying power (what you can afford). Most people actually start searching online, sometimes months before they are ready to start the process. There’s nothing wrong with that. But, when it is time to get serious you need to know the difference between a “pre-qualification” and an actual “pre-approval”.
A statement from your potential lender stating that you can afford to purchase a home up to a specific amount is called a Pre-qualification Letter. The problem with this pre-qualification letter is that it is based on very minimal information (typically just your credit score and a few questions).
A pre-qualification letter is not an official approval. It typically states the conditions that are still required in order to actually pre-approve you for the amount stated. Typically these verification of income, debts and cash on hand (in your bank account).
A pre-approval letter goes the extra few steps not covered above. The loan officer has done more than just check your credit. They have reviewed w-2’s, 1099’s or other income statements (like recent paychecks). They have also verified how much cash you have available for a down payment.
Keep in mind is that when you get a pre-approval, it is in the very beginning stages of your search. We have not identified a property, a purchase price or a timeline yet. As a result, we call this a PRE-approval.
An actual approval comes once you have written an offer on a specific property with a target closing date. At that point, the loan underwriters will really dig into your debt and income. As a result, they’ll be able to determine if they will lend you the money for this purchase.
An approval is given after the property has appraised at value. This simply means that the appraisal came in at the purchase price or higher. There are other items like debt-to-income ratios. If everything checks out, the lender will approve your request for financing the loan.
My purchase agreement has a finance contingency in it. This allows you to cancel the purchase without penalty if the lender disapproves the financing request.
Sellers like to see offers accompanied with a pre-approval vs a pre-qualification. This is because they know a buyer that is pre-approved is more likely to get an actual approval once they go under contract. You want to set yourself apart from the crowd by making sure your offer comes with a pre-approval letter.