Have you decided to purchase a home?
Well, congratulations, I bet you can’t wait to get out there and start looking for your new place.
However, before you begin house hunting, check whether or not you qualify for a mortgage, and, If you have already done so, do you know how much you can borrow? Oh, and don’t forget the difference between how much you can borrow and how much you should.
This is where the mortgage prequalification letter comes in. Not only will the process of getting the letter help prepare you for the process of applying for a mortgage, but it can also help speed up the home buying process by:
- Providing you with a maximum spend figure, which enables you to decide which homes to view.
- Showing the seller that, should you make an offer, you can actually afford to buy their home,
When you apply for a prequalification, you visit a lender with the details of your debt, income, and assets. Using the figures you provide, the lender will be able to give an estimate of the mortgage amount they might be willing to offer.
However, as you know, almost everything around us has pros and cons. So, before you opt for a mortgage prequalification letter, let’s take a good look at the upsides and the downside.
The Pros Of A Prequalification Letter
There are plenty of good reasons why you should apply for a prequalification letter.
It Helps You To Plan Your Home Hunt
When we start thinking about buying a home, the first step for most of us is to use an online mortgage calculator. These tools vary slightly from site to site, but they do give us a rough idea of how much we might be able to afford. The trouble is, there are so many variables in working out how much you can afford, online calculators are only really good enough to give you a rough, ballpark figure.
Therefore, once you decide you are serious about looking for a home, you should begin interviewing lenders and determine who you would most like to work with. Then, you can book an appointment to discuss a prequalification letter.
At a prequalification appointment, the lender evaluates:
- Whether or not you qualify for a loan at all.
- How much you can afford in monthly payments.
- The maximum mortgage loan you might be offered.
Then, assuming you qualify for a loan, you will have a clearer idea of how much purchasing power you have. As a result, you then know which homes are within your financial reach and can narrow down your search. Viewing homes within your budget is important for both buyer and seller.
- A seller does not want to accept an offer and begin the sales process only to discover, two or three weeks down the line, that their home was way out of the buyer’s budget, and they have been refused a mortgage. As a result, the seller has to begin showing their home again and may have missed out on other potential buyers.
- You, as a buyer, do not want to waste your time and emotional energy viewing homes you cannot afford to buy. This will only make you miserable and taint the buying process for you.
A Prequalification Letter Helps You Plan Your Budget
If you receive your prequalification letter and the amount you might be offered is not what you hoped, don’t despair. Look at this as a good thing. You now know exactly where you stand and that you cannot afford the kind of home you want to buy.
Why is this a good thing?
Instead of looking at homes now and getting down because you can’t afford them, you have the chance to review your finances. Look at:
- Expenses you could eliminate
- Debts you can pay down
- Ways to save more for a deposit
- Opportunities to increase your income
Take this opportunity to carry out a financial check-up. Identify, honestly, where you are today, decide where you want to be by a specific date, and make a plan to get there.
A Prequalification Application Does Not Affect Your Credit Score
Applying for a mortgage prequalification won’t affect your credit score; because a pre-qualification pulls what is known as a “soft” credit inquiry. Meanwhile, applying for a mortgage preapproval will result in what is known as a “hard” credit score.
Do you know the difference between a soft credit inquiry and a hard credit inquiry?
Well, the credit monitoring companies keep a record of certain financial details, and they use this to calculate your credit score. Among other things, they look at your income, the reliability, and length of your employment, your current debt load, and your record of repaying your debts.
When the credit monitoring companies are asked, by anyone, about your credit record, they decide what kind of inquiry is being made. Some inquiries will affect your credit score. For example, if you apply for several loans or credit cards in a short period, the credit companies will wonder if you are having financial difficulties and need more credit to cope.
For this reason, when you apply for any kind of loan, mortgage, or other credit product, the check on your record is a “hard” check and can affect your credit score. These hard checks are recorded on your credit history and are viewable by anyone who does a credit check.
On the other hand, there are plenty of reasons why someone may want to see your credit report, without it being linked to a credit application. Some examples of soft inquiries apart from mortgage pre-qualification are:
- You check your own credit report
- Your present creditor(s) check your report for account maintenance
- Your employer might pull your credit report for screening purposes
- An insurance company might check your credit report to determine the eligibility or the pricing of the new policy.
- A credit card company may pull a soft inquiry to see if you would qualify for one of their products. If they think you are a good prospect, you might receive one of those unsolicited credit card offers.
Soft credit inquiries aren’t viewable except in the consumer disclosure report you will receive if you check your own credit report.
In short, a prequalification letter requires a soft credit inquiry, and as a consequence, it doesn’t affect your credit score. On the other hand, if you apply for a preapproval, there will be a hard credit inquiry, and your credit score may take a hit.
The Con’s Of A Prequalification Letter
The majority of the cons of a prequalification letter arise because many people do not realize the is a difference between prequalification and preapproval. They are not the same thing. Therefore the cons of a prequalification are:
It Is Not A Binding Agreement
A prequalification letter is purely informational. It gives you a rough estimate of what you can expect to be offered, should you go through the full mortgage application process. It does not tie the lender down or oblige them to provide you with a mortgage.
The Figures May Change
Many people have been shocked to discover that they have a prequalification letter for X amount of money. Still, when they come to apply for a mortgage, they are either turned down entirely, or they are offered a smaller mortgage.
This happens because:
- The borrower’s figures may not have been accurate when they applied for a prequalification.
- The lender’s policies may have changed.
- There may have been an increase in mortgage rates.
- The borrowers may not qualify for the specific mortgage they want but can be eligible for a different mortgage product, which offers them a lower loan amount.
- The borrower’s situation may have changed since they applied for the prequalification, and as a result they no longer qualify for the loan.
In response to this, many people ask, “well, what is the point of a prequalification letter?”
What Is The Point Of A Prequalification Letter?
It comes down to the fact that you can obtain a prequalification letter reasonably quickly, with a soft credit check and without providing proof to back up your figures. For many people, this is enough because their figures are accurate, and they can be reasonably confident their full mortgage application will be approved.
Other people may attempt to fudge their numbers, minimize their debt, and inflate their income when applying for a prequalification in order to obtain a higher figure for their mortgage. They can get away with this ss there is no requirement for proof.
As a consequence, because the lender does not know for sure if the figures they have been given are accurate, they will not say for sure whether or not they will provide the loan.
So, a prequalification letter provides you with a clear idea of what you might borrow, without the burden of going through a lengthy administrative process to check your figures. In the meantime, it does not oblige the lender to go ahead with the loan, protecting them from unsubstantiated applications.
Should I Opt For Preapproval?
You can certainly consider applying for mortgage pre-approval. Real estate agents will confirm that sellers look on a preapproval more favorably than they do a prequalification. This is because a preapproval is as close to a guarantee you can get that a buyer will be able to obtain a mortgage and complete the sale.
When faced with multiple offers, all other things being equal, a seller is more likely to accept the offer from someone with a preapproval than they are from someone with a prequalification.
However, a mortgage pre-approval application is a longer, more drawn-out process. Preapproval means the lender is confident that you can make the necessary payments on time, and you have sufficient income to cover your future mortgage payments. In order to say this, the lender will want to check and double-check your financials, complete with documentary proof and other inquiries. This takes time.
Why A Preapproval Is Not A Guarantee
The reason why a lender will not guarantee a mortgage is that your financials are only part of their decision-making process. The lender will also need to ensure the property’s value offers sufficient collateral to cover the amount they lend you. This way, if you default on the loan, the lender will be able to recoup their costs. Until the appraisal and home inspection process has been completed, the lender cannot know the value of the home for sure. Hence, a preapproval effectively says:
“Yes, you can definitely afford this much to buy a home, and we are willing to lend it to you. However, we have to check out the home itself before we give you the loan just in case it’s not worth the sales price.”
To obtain a preapproval, you need to fill out a uniform residential loan application with your personal information, including:
- Your residential address or addresses for the past two years.
- Contact Information for your landlord(s), if applicable, as well as how much rent you have been paying.
- Your bank account statements for all checking, savings, and brokerage accounts.
- Your pay stubs for at least the past 30 days. Depending on how you are paid (regular hourly wage, contract hours wage, commission, tips, etc.), the lender may require up to one year of pay records – occasionally even more.
- Your W-2s for the past two years.
- Your social security number so that the lender can pull your credit report – remember this is a hard inquiry, so they have to double-check they are pulling the correct file.
If you do apply for a mortgage preapproval, your credit score might drop, but it should not be by a significant amount. This potential drop means that if you are not seriously house-hunting, do not apply for a preapproval.
A preapproval is only valid for a limited time, usually 60-90 days. If you have preapproval and it expires, and you then apply for another or, even worse, if you keep doing this for months on end or apply for multiple preapprovals from different lenders at the same time, your credit score may be affected badly enough to have an impact on your mortgage application.
Will Using My Credit Card When I Have A Preapproval Damage My Credit Score?
As long as you use your credit card and any other credit products sensibly, they should not negatively impact your credit score. In fact, if you are looking for ways to improve your score, the responsible use of your credit card can actually help. You can:
- Use your credit card regularly. If you do not usually use your card, then break it out and pay for your groceries, gas, or other regular outgoings and pay them off at the end of the month.
- Make your payments on time and always pay at least the minimum amount.
- Pay down your cards, so they are not at the top end of your credit limit.
Using these simple tips, you will eventually notice a gradual increase in your credit score.
What If You Already Have A Large Amount Of Creditcard Debt? Then you can go for an apt debt relief option and try to pay off credit card debt at the earliest.
What’s In A Preapproval Letter?
Once you have completed the process, the lender will issue a preapproval letter.
In it there will be the following:
- Your basic details – although none of your financials will be included.
- Your lender’s details.
- The specific mortgage product for which you have been approved.
- The maximum amount of money the lender is willing to offer you.
So, don’t wait.
If you are planning to buy your dream home, take the first step, and consult with your lender about whether a prequalification or preapproval is right for you and your current situation.
Best wishes in advance for your house hunting.
About The Author
Aiden White is a financial writer who lives in Foster City, California. She started her financial journey in 2015 and has been associated with consolidatecreditcard.org
This article has been reviewed by our editorial board and has been approved for publication in accordance with our editorial policy.