May 17, 2017

What Does Prequalify for a Mortgage Mean?

Read more about Mortgage

When you're told you have prequalified for a mortgage, it can give you some confidence about buying a home - but not much else. Here's what it means.

Before you shop for a home, it helps to know what you can afford. One way to find out is with a prequalification from a lender. It's an estimate of the size of the loan you may obtain. It does not commit you to a loan or a particular lender. What it does do is give you a place to start the home buying process.

Here we explain why you should get a prequalification and how to start.

Prequalified vs. Preapproved

Don't confuse the terms prequalification and preapproval. Think of the prequalification as the starting point while preapproval gets you much closer to actually signing a mortgage.

A prequalification is very basic. Consider it a measure of what you might be able to afford. It is not promise to lend you money in the future. Lenders base the prequalification decision on the basic information that you provide.

At this point, lenders do not ask you for proof of the information you give them. They do not even pull your credit yet. They base the estimate on your:

  • Income
  • Estimated monthly payments
  • Total assets

These figures help the lender determine how much you "qualify" to receive. Estimate is the key word in this process, as they verify nothing.

The preapproval goes much further. Sellers prefer to see when buyers are preapproved since it shows seriousness and confirms the buyer can actually buy their house. It's a more concrete way to give sellers confidence in your ability to secure a loan.

If you only have a prequalification letter at the point you make an offer on a house, sellers won't be impressed. They or their real estate agents will likely know that the prequalification is just a review of what you told a lender. It does not provide any concrete answers to what you could afford.

Tip: Your credit score helps determine the type of loan you can obtain. Without knowing your score, a lender can only give you a loose idea of what you might receive. They may change their minds later if it turns out your score falls below a certain threshold.

The best way to look at a prequalification: It's a starting point. It sparks a conversation between you and a bank that you may want to do business with. And it gives you an idea of what type of home you can possibly afford.

Sometimes you could be prequalified in an instant. You fill out the information on a website. You don't even talk to a loan officer. Certain large banks offer an automated answer, like what you get when you apply for a credit card. This should give you an idea of how loosely regarded the prequalification is by lenders.

Lenders use a prequalification as a lead generation system. This is why you may see online programs offering an instant answer. Lenders use the information they obtain to market their products to potential clients.

Taking the First Step

Use the prequalification as the first step in the home buying process. Talk to several lenders before you shop for a home. Because there is no commitment involved, you can shop around. This gives you a better idea of what is available to you.

Your mortgage is a very large investment. You borrow large amounts of money that you agree to pay over the next 15 to 30 years. You want to work with a bank you trust. Going through the prequalification process can help you see which bank you prefer.

How the Prequalification Process Works

The prequalification process is very simple. You provide a lender with the following information:

  • Name
  • Address
  • Amount of gross monthly income
  • Amount of monthly debts (car loans, student loans, personal loans, credit cards)
  • General idea of your credit score (if you know it)
  • How much money you think you want to borrow
  • How soon you think you need the loan

The lender uses this information to come up with the amount you may be able to afford.

Important Tips for Obtaining a Prequalification

While the prequalification is a simple and very non-committal process, there are ways to make the most of it. We encourage you to take it seriously because it helps you understand what you can afford. If you have never owned a home before, this step is crucial. This process also helps you get familiar with the mortgage industry. It helps you understand various terms, what you need to get a loan, and what you need to change. Following are a few ways to make the most of it.

Research Different Loan Programs

There are numerous loan programs available today. FHA, USDA, VA, and conventional loans are a few types of loans you may hear about. Take the time to familiarize yourself with these loan types. If this is your first time hearing these terms, read our article "Different Types of Mortgages" to learn more.

Research Different Lenders

Shopping for a lender takes a lot of work. Doing this during the prequalification stage is the perfect time. Because you are not looking for a commitment at this point, you can determine what different lenders have to offer. You might discover, when you apply with certain lenders, that you do not prefer their way of doing business. It is better to find these things out before you find a home.

During the prequalification stage, you usually have plenty of time to figure things out. Before you start shopping, read about various lenders online. See what others have to say and look at their various offerings.

Prepare for Your Prequalification

Even though the prequalification is not a commitment, you should make the most of your efforts. Treating it as if it were your mortgage will help you get the most accurate answer. Before you start talking to lenders, take a good look at your financial life.

Start with your credit. You are eligible to receive a free credit report from each of the three credit bureaus annually. Request a copy from Equifax, TransUnion, and Experian. Look over each report carefully to ensure accuracy. This is also when you can figure out if you have any "cleaning" to do. If you have late payments, collections, or overextended credit, now is the time to fix it.

If you plan to talk to a loan officer in person, go ahead and bring your paperwork. Even though it is not required, it gives lenders a more concrete idea of what you are working with. It tells them what type of income you have, how much you make, and how much money you have saved up.

Think of this as an opportunity for the lender to tell you what you need to fix. Because this is a preliminary step, you have time to figure things out. For example, a lender may not accept recent large deposits in your checking account. They may recommend that you wait until the funds are in your account for at least six months before applying for a loan. This is called seasoning and means sitting in your account for a specific amount of time.

The prequalification process lets lenders give you advice before you formally apply for a loan. This helps you make yourself as eligible as possible in the future.

Tell the Truth

It does not do you any good to lie during the prequalification phase. Inflating your income, minimizing your debts, or exaggerating your credit score will not help. Once you provide documents for lender verification, the truth will come out. The lender will be unable to qualify you for the loan they estimated you could afford. And you won't be able to move forward on your home unless you can find another lender.

A Step Further than the Prequalification

Once you secure the prequalification, you need to take things a step further with a preapproval. This is the step where you provide the lender with documents to back up the claims you made for the prequalification. You will need to provide the following documents:

  • Paystubs showing the last 30 days of income
  • Name, address, and phone number of your employer to verify your employment
  • W-2s covering the last two years of employment
  • Tax returns for the last two years if your income is anything but salary
  • Asset statements proving the money you have for a down payment

The lender uses these documents to determine what you can afford. If you were honest about your income, debts, and credit score, the amount may mirror the prequalification.

Certain things may make the amount different. For example, the lender may calculate your income differently than you do. A few examples include hourly employees or those working on commission. Other issues that pop up include debts you forgot about or a lower credit score than you thought you had.

To learn more about the preapproval process, read our article "Mortgage Pre-Approval."

Bottom Line

Going through the prequalification process makes sense. It provides guidance regarding what steps you should take next. If you have things to fix, the lender can point you in the right direction. A prequalification doesn't cost anything and does not commit you to anything. At the very least, it keeps your home search within a reasonable budget. It also lets you know where you stand. The home buying process is stressful. Anything you can do to make it less complicated is well worth it.

More from CreditDonkey:

Pre Approval Mortgage

Buying Your First Home

Underwriting Process

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