Pre-qualification vs. Pre-approval

Jul 19, 2022 By Susan Kelly

A mortgage pre-qualification is useful in estimating how much a person can afford to purchase a house; however, a pre-approval can be far more important. It indicates that the lender has assessed the creditworthiness of the prospective buyer and verified the paperwork to authorize a particular amount of loan (the approval is usually for a certain period of time, which could be 60-90 days).

Potential buyers can benefit by speaking with a lender and obtaining an approval letter. They will have the chance to discuss financing options and budgets with the lending institution. The lender will review the credit of the buyer and find any issues. The homeowner will also know the limit to how much money they can take out, which can help determine the cost range. A mortgage calculator is an effective tool for budgeting costs.

Pre-approval Requirements

Evidence of Income

Buyers typically need to produce W-2 wage statements for the last two years, the most recent pay stubs showing earnings and year-to-date earnings, proof of extra income like bonuses or alimony, and the most recent two tax returns for the previous year.

Evidence of Assets

The borrower will require bank statements from their investment accounts to show that they have sufficient funds for the down payment, closing costs, and cash reserves. The down payment, expressed in the selling price percentages, differs based on the kind of loan. Many loans require that the buyer takes out Private Mortgage Insurance (PMI) in addition to paying an insurance premium for mortgages or a financing fee if they put down at less than 20 percent of the purchase price.

Alongside the down payment, pre-approval depends on buyers' FICO credit score, debt to income (DTI) rate, and other aspects contingent upon the kind of loan. All other loans comply with the federally-sponsored enterprises (Fannie Mae and Freddie Mac) guidelines. Certain loans, like HomeReady (Fannie Mae) and Home Possible (Freddie Mac), are specifically designed for those homeowners with low to moderate incomes or first-time homebuyers.

Good Credit

Most lenders require the FICO score of at least 620 for approval of the conventional loan, and some require this score to be met for the Federal Housing Administration loan. Most lenders offer the lowest interest rates for those with scores of 760 or more. FHA guidelines allow those with a credit score of 580 and above to put only 3.5 percent down. For those with lower scores, they must make a bigger down payment. The lenders will typically deal with moderately or poor credit scores and offer ways to increase their credit score.

The following chart shows the monthly principal and interest payments for a fixed-interest 30-year mortgage based upon the spectrum of FICO scores for three typical amounts of loans. Take note that for $250,000, a homeowner with a lower FICO score (620-639) would have to pay $1,288 per month. In contrast, homeowners in the top (760-850) range would only pay $1,062, a difference of $2,712 annually.

At the current rates and over the 30 years on the $200,000 loan, anyone with a FICO score of 620-639 area would have to pay $213,857 as interest and principal, and a homeowner who falls in the 760-850 range will be paying $132,216 - an increase of over $81,000. A tool for calculating interest rates provided by the CFPB lets you know how your credit score, the type of loan, and home's price, can impact your interest rate. This tool updates to reflect current interest rates every week.

Employment Verification

They want to make sure they only lend to borrowers with steady jobs. A lender won't just need to look over the pay stubs for a buyer but may also contact the employer to confirm that the employee is employed and has a salary. A lender might call the employer of the previous one when a customer has recently switched jobs.

Self-employed buyers need to be able to provide additional documents regarding their income and business. In the words of Fannie Mae, the elements that determine the approval of the mortgage of self-employed borrowers include the stable income of the borrower along with the location and the nature of the company, the need for the product or service provided by the company as well as the financial stability of the company, and the capability of the business to generate and distribute enough income to allow the borrower to pay the monthly payments for the mortgage.

Other Documentation

The lender must duplicate the borrower's driver's license and will require their Social Security number and signature for the lender to access the credit report. Make sure you are prepared for the pre-approval appointment and supply (as quickly as possible) any additional documentation required from the lending institution.

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