This is a topic that comes up all the time with homebuyers, so I wanted to share a recent write-up by William M. Mullin, the President of NE Moves Mortgage. I’ve added a few of my own comments in brackets within the text.
There can be confusion between the terms pre-approval and pre-qualification. Some loan officers and lenders will occasionally use the terms interchangeably [and I believe Bank of America, and perhaps a few other lenders now ONLY offer pre-quals]. However, there is a significant difference.
Generally speaking a pre-qualification merely means that the customer has met with the loan officer. The customer then shares certain of their information with the loan officer, typically how much they earn, how much they have available to put as a down payment, and, they hopefully discuss their debts. The loan officer then takes this information, runs the borrowers debt to income ratios at current interest rates and tells the customer they are pre-qualified for a certain loan amount. This information is for the benefit of the potential borrower as they then think about a purchase. While the pre-qualified amount may be shared with an agent or a potential seller, it is clearly not a pre-approval. [Frankly, a pre-qualification letter is not worth the paper it’s printed on, since nothing is verified.]
A pre-approval is a much stronger document. Here the loan officer should secure the consumer’s permission to actually pull their credit report to validate the status of the borrower’s credit and determine their FICO scores. At this stage any negative credit, disputes or discrepancies should be addressed. The loan officer should also validate the borrower’s income. This should be done by reviewing the borrower’s pay statements, W-2’s and tax returns. [This is VERY important because the requirements for a salaried employee and an independent contractor being paid with 1099s are different. I’ve had buyers who were “pre-qualified” for a certain purchase price based on their stated income, but because they were independent contractors and didn’t yet have two years’ of tax returns, they were in fact not qualified to buy anything — only a thorough pre-approval will reveal this.] Additionally the loan officer should validate the borrower’s assets by reviewing their bank and/or brokerage statements. Questions regarding potential gift funds and the donor’s ability to give these funds should also be addressed at this point. The loan officer will then submit all of this information to either Fannie Mae or Freddie Mac’s automated underwriting engines. Once all of this has been done the loan officer or the lender can issue a pre-approval that is quite strong. Is it bulletproof?
Sadly, very few things in life are 100% certain. While the consumer may be well qualified for the loan there is always the possibility that the property fails to appraise out. [Or, in the case of condos, the association has low owner-occupancy, too much commercial space, or one entity that owns more than 10% of the units.] And, unfortunately, once in a great while the consumer may fail to provide the loan officer with accurate information which can then negate the pre-approval. Or, once the pre-approval has been issued, the consumer may take an action that invalidates the pre-approval. Some classic examples of this include the consumer losing their job, the consumer changing their job from that of a salaried employee to becoming selfemployed or by increasing their debt level through new borrowings after the initial credit report was reviewed.
Under any circumstances, however, the pre-approval is the way to go. When properly done, as outlined above, it can give both the agent and the seller a high degree of certitude that the transaction will be consummated.
~ By William M. Mullin, President, NE Moves Mortgage, LLC
By the way, you should never have to pay for a pre-approval. At NE Moves Mortgage, they are always free. Contact Jono Sexton at my Cambridge office and he’ll take good care of you!