Getting approved for a loan is much different than it was a decade ago. In the past there were multiple options and programs for every different income type and down payment. Today there is much more documentation required and everything is much more scrutinized. A seemingly innocent document requested at the 11th hour could cause the loan to be rejected. All the weeks, and months, that both sides put into the transaction could see it go to waste with an underwriter’s decision. Your loan is truly never closed until you sign the documents at the closing table. That is why it is critical to make sure every potential buyer is not just prequalified but actually pre-approved. This may seem like semantics, but the difference is tangible and could save you weeks of potential trouble. If you are selling a property or looking to make an offer you should understand the difference between these two. Here are a few differences between a pre-approval and a pre-qualification.
A pre-qualification is the very first step in the loan approval process. Very few, if any, real estate agents will show you a property without a pre-qual letter in hand. A pre-qual is obtained by reaching out to your local mortgage broker, bank or credit union. Prior to issuing a pre-qual letter the lender will ask you a series of questions to determine the strength of your application. The starting point is almost always a review of your credit score. Your score will either eliminate a handful of programs or put you square in line for others. It is important to note that a credit score for a loan application may not be the same as one you pull for yourself online. Anything over a 720 score is considered excellent, and anything under a 580 may give you limited options. Everything in the middle is usually tiered on a 20-point basis meaning there could be a huge difference between a 618 score and a 621.
In addition to credit the next most important item a lender will review is something called your debt to income ratio (DTI). The is a formula where the lender takes all the minimum monthly payments on your credit report and adds them to your proposed total monthly payment. This number is then divided by your gross monthly income (annual income/12). Each lender and program are slightly different, but the benchmark is generally 50%. If your DTI is above 50% you may have a tough time getting approved regardless of your score or down payment. Conversely, if your debt to income is low it can help open doors for other potential programs.
The final major pre-qualification item that is noted is the down payment amount. As is the case with your credit score, down payment is broken up in tiers for loan program purposes. 3, 3.5, 5, 10, 15 and 20 are generally the most common down payment percentages. You can always put down a number between those, but you will have the same rate scale as the previous tier.
Once a lender has this information they can play around with how much down payment is needed based on the credit score and debt to income and issue a pre-qualification letter which can be used to start a new home search.
There are many people involved in real estate who have been burned by a poor pre-qual letter. The truth is that a potential buyer can say anything they want to strengthen their application. They may really even think they are telling the truth, but in reality, their income may less than they think, or they are not employed for a minimum amount of years. The only way to get past this is by submitting real documentation to a lender prior to house hunting.
There are several lenders who will submit an application complete with real paystubs, tax returns and a full credit report. Basically, everything except the signed contract, title and homeowner’s insurance will be reviewed. It is not an exaggeration to say that this can literally save a buyer weeks in the approval process. Once they find a house and have a signed contract they send that over and the loan is more than halfway to closing. As we stated, at that point all that is needed is a review of the contract, title and homeowner’s insurance.
Gone is the guesswork on how an underwriter will review self employed income or other items on the tax return. There is no hoping that the debt to income ratio is approved or the employment signed off on. If you are selling a home, you need to work with a real estate agent who knows the difference between a generic pre-qualification letter and an iron clad pre-approval.
Starting out with a buyer who is at least a few weeks ahead of their competition is something that cannot be overlooked. Things happen at every stage of the loan process, but the main hurdles usually come with the tax returns and income documentation. Once you are past those 90% of the issues can be rectified. Whether you are selling a home or working with a buyer you need to make sure they are not just prequalified, but pre-approved.
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