Getting prequalified or preapproved for a mortgage is a must if you want to buy a property. As a buyer, you need to present yourself in the strongest financial manner possible. Otherwise, the seller won't bother to take a risk getting into contract with you, especially if there are competing offers.
From a seller's point of view, selling a property is much more stressful than buying a property. So many things need to go right in order for a real estate transaction to occur. From a buyer's point of view, it's much easier to walk away unscathed and untainted from a real estate contract.
The terms prequalified and preapproved are often used interchangeably. However, there is a big difference between the two. Getting preapproved is much more impressive and impactful.
As someone who has bought and sold multiple properties in Honolulu, Lake Tahoe, and San Francisco, let me explain the difference between prequalified and preapproved and why it's much better to get preapproved.
Prequalifed Versus Preapproved
What Is Prequalification?
Prequalification is the initial feeling out stage of a lender and borrower relationship. When you prequalify for a mortgage, you’re getting an estimate of what you might be able to borrow based on your income, cash available, size of your investments, and other financial assets and liabilities. You will also allow the lender to check your credit.
Consider prequalification more like dating. You and the bank are still trying to get to know each other, but you're not 100% serious yet. You can use the prequalification process to figure out what type of mortgage you want to get, such as an adjustable rate mortgage or a 30-year fixed rate mortgage. This is the time to also figure out what type of interest rate you will get as well.
With prequalification, a lender has not committed to lending you any money. The lender is just giving you an idea of what it might be able to lend you. As the borrower, you have not committed to borrowing any money from the lender either. You can go to any lender you choose.
What Is Preapproval?
Preapproval is a much more advanced qualification that puts the buyer in the driver's seat to submit an offer with full confidence. You will complete a mortgage application and the underwriter will fully analyze all your financials to come up with exactly how much they are willing to lend you. The lender will also perform a credit check.
If you’re preapproved, you’ll receive a preapproval letter, which is an offer (but not a commitment) to lend you a specific amount, usually good for 90 days. Once the 90 days is over, you have to go through the preapproval process again if you still haven't found a home.
The preapproval letter will specify how much the lender has already offered to lend the buyer. Therefore, before you submit an offer, you need the letter to reflect an appropriate amount so as to not give the seller hope for a higher offer.
In other words, if you are approved for $1 million, but you want to offer only $900,000 for the home, the preapproval letter shouldn't say you are preapproved for $1 million. Instead, it should say how much you are approved for based on your offer price minus your down payment.
Consider preapproval more like getting engaged. You are 98% committed to each other and plan on getting married. But unlike getting engaged, you don't have to buy a costly engagement ring. Getting prequalified or preapproved is usually free.
The mortgage rate you will get for a prequalification or preapproval is also not fixed. It is just an estimate rate. Once you find a property and get into contract, you will lock in a mortgage rate until the transaction is complete.
How To Get Preapproved
The very first thing you need to do is find a reputable lender. One of the easiest ways to do so is by finding one online through Credible, my favorite lending marketplace today. Credible has already pre-vetted the best lenders on its platform so you can get real mortgage rate quotes in minutes, all in one place. These qualified lenders are competing for your business, which means you are efficiently letting the market allow you to get the best mortgage rate possible.
Another way to start the preapproval process is to contact your main banking relationship. Perhaps you already have a mortgage with the bank or you have multiple accounts with them. It's always nice to go through the preapproval process with a lender you already know.
What Your Lender Wants To Know For Preapproval
To get preapproved, you will have an initial discussion before starting the underwriting process. Banks get approached all the time from people who want to borrow money. To safeguard their time, they need to carefully screen each potential client first.
Before you speak to a lender, you need to have a good answer for the following points below.
The lender will want to know approximately when you plan to buy. Ideally, you want to get preapproved one day before you find that ideal property because preapproval won't last forever. After a couple of months, you will have to resubmit financial documents.
You also don't want to get preapproved more than two weeks after a property first lists, because your competitors will have had more time to put in a better offer.
Price of property
The lender will want to know the approximate price range of the property. If you have a specific property in mind, you can send him or her the listing. It's important to get approval for the maximum property price.
It's much easier to change the terms and get preapproved for less money than more money. If you decide you need more money, you may have to go through a time-consuming underwriting process again.
Permission to do a credit check
To get preapproved or prequalified, the lender needs to check your credit. The credit check usually shouldn't cost you anything and usually shouldn't hurt your credit score, unless you've had multiple credit checks within the last couple of months.
Plans for existing residence
The lender will want to know what you plan to do with your existing residence. Sell or rent it out are the two usual options. But other options could include leaving the property empty, turning the property into a home office, or letting a friend or relative live on the property rent-free.
Duration at existing residence
If you refinanced your primary residence within the past 12 months and plan to get a purchase mortgage with the same lender, you may hit an underwriting road bump. The reason why is because most primary mortgage refinances require the homeowner to sign-off that he or she plans to live in the home for the next 12 months.
This agreement helps protect the bank from property owners who try and refinance rental properties or properties earmarked for rental as a primary residence. Mortgage rates for primary residences are often 0.25% – 0.75% lower than mortgages for rental properties.
If you go with a lender who did not refinance your existing primary mortgage within the past 12 months, you may not have to go through any delays due to further underwriting scrutiny.
Documents Needed To Get Preapproved For A Mortgage
Once you've got a chance to get to know each other, the lender will ask for the following documents. At this stage, you still don't have to sign any papers or contracts.
Here are the documents your lender will likely ask from you to get preapproved:
- Two most recent paystubs (months)
- Two most recent W2s (years)
- Two most recent 1099s if applicable (years)
- Two most recent tax returns (years)
- Two most recent investment statements (months)
- Two most recent checking and savings account statements (months)
- Latest business profile and loss statement and balance sheet if applicable
- Mortgage and HOA statements for all investment and vacation properties
- An explanation for all large (over $1,000) banking transfers and deposits during the last two months
- Printouts of large (over $1,000) checks during the last two months
Even after you've sent all the requested documents, the lender will often ask for even more documents. Don't get frustrated, stay focused and organized. Keep on sending as many documents the lender requests, but no more.
Explanation Of Purchase
In addition to requiring plenty of recent financial documentation, your lender may also want you to write a short note stating why you want to buy. Don't be baffled by this request, just comply. It should be relatively easy to explain. And if it is not easy to explain why you want to buy, perhaps you shouldn't be going through with the preapproval process. Taking on debt and buying property is no joke. It is a significant financial commitment.
A short explanatory note can either be done in an e-mail or in a word document. Here's an example:
I'd like to get preapproved for a mortgage because my wife just gave birth to our second son and we need a larger home. We also believe that there is an opportunity to take advantage of softer real estate prices now that we are going into a recession.
We are looking to buy a $1 million house with a $800,000 mortgage. Our jobs are stable and we have high credit scores. Thank you for your time and consideration.
A Financial Samurai
Preapproval Is All About Offering The No-Financing Contingency
If you don't have all-cash to buy a property, the next best thing is getting preapproved so you can offer a no-financing contingency offer.
A no-financing contingency offer is as good as a cash offer because your lender has already preapproved the amount they are willing to lend you. If you have a large, reputable bank preapproving you, all the better.
A financing contingency gives a buyer a risk-free exit if he doesn't get approved for a mortgage or doesn't like the terms of his mortgage. In this situation, the seller's successful sale is dependent upon both the buyer's price decision as well as the lender's.
With a true all-cash offer, the fastest closing time is usually between 10 – 14 days. With a no-financing contingency offer, the fastest time to close is usually about 21 days. Either way, closing in 10 – 21 still compares favorably to 46 days, the average time it takes to close on a new home purchase according to Fannie Mae.
Get Preapproved If You Want To Buy Property
If you want to be a competitive buyer, then it's important to get preapproved for a mortgage. Getting prequalified really doesn't carry much weight to the experienced seller or the experienced selling agent. It can often take two to four weeks for a bank to approve a loan once you submit an offer.
A seller wants a preapproved buyer who doesn't have a financing contingency. A quicker close is preferably to a longer one, since so many things can go wrong during the contract period. A preapproved buyer can often get a better price as well given some sellers are willing to pay a price for certainty.
If you're looking for a qualified lender with a low mortgage rate, check out Credible, my favorite mortgage marketplace where lenders compete for your business. You can get competitive, real quotes in under three minutes for free. Mortgage rates are down to all-time lows! When banks compete, you win.
Real Estate Investment Alternative
Buying a property to live in or rent out is definitely one way to build wealth over time. Another way to invest in real estate is through real estate crowdfunding.
Take a look at CrowdStreet, one of the best real estate syndication platforms that focuses on faster-growing 18-hour cities that have much lower valuations. Instead of leveraging up to buy one property, you can buying multiple properties without debt. It's free to sign up and explore.
Another real estate crowdfunding platform favorite is Fundrise. They have unique private eREITs that gives you diversified regional real estate exposure and different styles of real estate investments. Fundrise has consistently provide stable returns compared to the stock market since inception.
About the Author: Sam worked in investment banking at Goldman Sachs and Credit Suisse for 13 years. He received his undergraduate degree in Economics from The College of William & Mary and got his MBA from UC Berkeley. In 2012, Sam was able to retire at the age of 34 largely due to his investments that now generate roughly $250,000 a year in passive income. He spends time playing tennis, taking care of his family, and writing online to help others achieve financial freedom too. He started Financial Samurai in 2009 and has grown it to be one of the largest independently owned personal finance sites in the world.