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Mortgage Pre-approval vs Pre-Qualification: Which is Better?

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Buying a home is a complex, overwhelming process, and there’s a lot of details to sort through. What type of property to purchase? Which mortgage lender to choose? What’s the best mortgage program? The list goes on and on.

One of the biggest decisions of the entire process, however, is how much to spend on a house. Fortunately, you don’t have to make this decision alone. The mortgage lender ultimately determines how much house you can afford based on several factors, such as your income, existing debt and credit.

Before setting out to purchase a home, it helps to have a clear idea of your range of affordability. To learn your price point and remove the guesswork, you have the option of getting pre-approved or pre-qualified for a mortgage.

Some homebuyers use these terms interchangeably, but there are differences between a pre-approval and a pre-qualification. By understanding the difference, you can decide which option is better for your situation.

What is a Pre-qualification?

A pre-qualification is often the first step in applying for a mortgage. You’re required to provide information about your income and credit score, but you don’t provide your Social Security number and the lender doesn’t pull your credit. Based on the information you provide, the bank estimates how much you’re “likely” to qualify for. There’s no commitment from the lender, nor does a pre-qualification guarantee a mortgage approval. It’s a preliminary step. Once you’re pre-qualified, the next step is submitting an official mortgage application and forwarding the appropriate documents to the mortgage lender.

What is a Pre-approval?

A pre-approval provides a more accurate estimation of how much you can afford. Unlike a pre-qualification—where the estimation is based on information you provide—a pre-approval involves a thorough assessment of your financial and credit history. The lender pulls your credit report to evaluate your payment history and debt, and you’ll submit income statements (tax returns, paycheck stubs, W2s) and information about other assets such as bank accounts and investments. Your application goes through an underwriting process and the bank confirms the source of down payment funds. If you meet the qualifications for a mortgage, the lender issues a pre-approval letter

Which Is Better?

So which is better: a pre-qualification or a pre-approval? It really depends on where you are in the home buying process.

A pre-qualification says that you “might” be a good candidate for a mortgage, and this process makes sense if you’re just starting to consider a home purchase and you want to know if you’re even eligible for a mortgage. On the other hand, if you are ready to move forward with a purchase, you can skip the pre-qualification and get pre-approved, which indicates that a decision has been officially rendered. In this case, you’re practically guaranteed a mortgage (as long as there are no significant changes to your income, employment and credit). You’ll be taken more seriously by realtors and sellers, and a written commitment from the lender gives you a competitive edge when shopping for a house.

Getting a Mortgage After Bankruptcy

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Filing a Chapter 7 or Chapter 13 bankruptcy can have a damaging effect on your credit score and delay any plans of purchasing a home. Whether you file bankruptcy to reorganize your debt or erase what you owe, your credit score can decrease by as much as 200 points. It takes time to recoup lost points and prove you’re worthy of credit again. And unfortunately, a bankruptcy remains on your credit report for up to seven to 10 years. During this period, it’s harder to qualify for financing.

But while you can’t get a mortgage immediately following a bankruptcy, you may qualify for a loan in the near future.

Be Patient and Wait Two Years

A bankruptcy is devastating to your credit history, but the good news is that the damage lessens with time. Be patient and give your credit score time to recover. You have to wait a certain length of time before applying for a mortgage. The wait times vary depending on the type of mortgage program. For example, there is a two-year wait period for getting an FHA loan after a Chapter 7, and a one-year wait period after a Chapter 13 (as long as you’ve kept up with payments under the reorganization plan). If applying for a conventional loan, you have to wait four years after a Chapter 7 and two years after a Chapter 13. Some lenders may approve your application sooner, but this approval often comes with a higher interest rate.

Rebuild Your Credit History

After a bankruptcy, lenders lose confidence in your ability to pay your debts. You have to regain their trust by rebuilding your credit history, which starts with paying your bills on time every month. This includes auto loans, student loans, credit cards and utility bills. A good payment history makes up 35% of your credit score, so you’ll want to avoid late payments, collection accounts and judgments. If you’re rebuilding credit from scratch, apply for a secured credit cards. You’ll need a security deposit, but it’s easier to qualify for these cards with bad credit. You can also ask your landlord to report on-time rent payments to Experian CreditBureau. This adds positive activity to your credit report and also helps rebuild you credit history.

Plan for a Large Downpayment

Buying a house requires a minimum down payment between 3.5% and 5% for an FHA and conventional mortgage, respectively. But unfortunately, even if your credit improves and you qualify for a mortgage two years after a bankruptcy, some lenders will require at least a 10% down payment. If you’re buying a $150,000 house, you’ll need $15,000 for a down payment. This is in addition to paying your closing costs, which can be as high as 5% of the loan balance.

Pros and Cons of Refinancing Your Mortgage

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When mortgage rates hit record lows, many homeowners consider a mortgage refinance. Refinancing involves applying for a new mortgage to pay off your current mortgage. The new mortgage typically offers a better rate and terms, resulting in substantial savings. But just because you’re able to refinance doesn’t mean you should. Refinancing makes sense in some cases, but it’s not the right choice for everyone.

Make sure you understand the advantages and disadvantages of refinancing, and then decide whether it’s the right time to apply for a new home loan.

Pros of a Mortgage Refinance

  1. Lower interest rate

If you have a fixed-rate mortgage loan, refinancing is the only way to take advantage of a lower mortgage rate. A lower rate can reduce your monthly payment and save thousands over the life of the loan.

  1. Convert an adjustable-rate mortgage to a fixed-rate

Refinancing allows you to switch from an adjustable-rate mortgage (ARM) to a fixed-rate.   The interest rate with an adjustable-rate mortgage varies over time, which causes monthly payments to increase or decrease. The interest rate with a fixed-rate mortgage remains the same over the life of the loan, resulting in predictable, stable payments.

  1. Cash out your equity

Selling your home is one way to tap your equity. If you don’t want to move, you can apply for a cash-out refinance and borrow up to a percentage of your home’s equity. You can use the money for a variety of purposes, such as home improvements, debt consolidation, business expenses, etc.

  1. Remove name off the mortgage

Removing an ex-spouse or a cosigner from a mortgage isn’t as simple as calling the mortgage lender and making a request. If getting a divorce or breaking up with a partner, you can transfer ownership of the house to this person and vice versa, but this act doesn’t remove a name from a joint mortgage. To accomplish this, you have to refinance the mortgage. You (or your ex) would have to apply for a new mortgage in your name only, and be able to qualify without the other person’s income or credit.

Cons of a Mortgage Refinance

  1. You have to re-qualify

The fact that you already have a mortgage doesn’t guarantee an approval when applying for a refinance. This is an entirely new mortgage and you have to complete the same process as acquiring the original mortgage. This includes filling out a mortgage application, authorizing a credit check and providing income documentation. Unfortunately, if your credit score has decreased since applying for the original mortgage, or if you’re earning less money, these changes can affect qualifying.

  1. You have to pay closing costs

Refinancing can result in a cheaper mortgage rate and lower payments, but it’ll cost you. Just like the original mortgage, you have to pay closing costs (loan origination fees, appraisal, credit fee, title search, etc.). Upfront fees can cost as much as 2% to 5% of the loan balance. Some lenders offer provisions to help borrowers cover the closing costs, such as including these fees in the mortgage balance, or paying a borrower’s closing costs and then charging a higher mortgage rate.

Documents You Need When Applying for a Mortgage Loan

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Getting approved for a mortgage loan isn’t as simple as getting approved for an apartment. Some landlords don’t care about credit history, and they may only ask for a tenant’s most recent paycheck stub. Buying a house is a more complex, formal process.

A mortgage is a 30-year commitment, and understandably, lenders have to be absolutely confident in a borrower’s ability to afford the mortgage payments. In addition to your credit report, the bank will require several pieces of documentation before approving your loan.

  1. Proof of Employment and Income

Qualifying for a mortgage generally requires 24 months of consecutive employment with the same company or within the same field. The lender will need copies of your W-2 forms from the past two years, as well as your most recent paycheck stubs to verify your current employment and income. Some lenders go further and also request a letter from your employer. You must be able to document any income you want the lender to consider during the application process. This includes income from child support, alimony and other sources.

  1. Tax Returns

It’s tougher to get a mortgage when you’re self-employed. You have to document your income and prove that your business is profitable. The lender will need to see your complete tax returns from the past two years, plus a year-to-date profit and loss statement. The underwriter not only evaluates your business income, but also your business expenses or write-offs.

Keep in mind that too many business write-offs can work against you. Instead of using your total income, lenders use your adjusted gross income (which is income after write-offs) to determine how much house you can afford.

  1. Information on Cash Reserves and Other Assets

Buying a house involves a down payment and closing costs, and lenders will check to make sure you have funds on hand for mortgage-related expenses before approving your application. Some lenders even require applicants to maintain a cash reserve after closing on the mortgage. To verify funds, the lender needs copies of all your bank account statements and information on other assets, such as rental properties you may own or other investments.

If you don’t have enough assets, the lender will need information on how you plan to pay these expenses. The bank will not allow you to borrow funds toward your down payment, but you can use a grant or a gift from a relative or friend. If you’re receiving a gift, the donor has to write a gift letter to your lender.

4 Things You Shouldn’t Do After Getting Pre-Approved for a Mortgage

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A mortgage pre-approval can speed up the home buying process, and it’s an excellent way to know how much you can afford before shopping for houses.

A pre-approval involves giving the bank your income statements, such as W-2s or tax returns. The bank reviews your income and credit history, and based on this information, either approve or deny your mortgage application.

A pre-approval letter indicates you’re a serious buyer, but it doesn’t guarantee you’ll make it to the closing table. A bank can still reject your loan, especially if you make decisions that change your financial picture.

To avoid any setbacks, here are four things you shouldn’t do after getting pre-approved for a mortgage loan.
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Advantage of Using a Smaller Mortgage Lender

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If you have an existing relationship with a big bank, you might choose it as a lender for your mortgage. These banks offer a buffet of mortgage products, but they don’t exactly cater to every type of borrower. Broaden your search and you may discover that small mortgage lenders can give the big guys a run for their money and even help you save some of yours.

Whether it’s a small credit union, a community bank or a mortgage company, here are three reasons why you shouldn’t overlook a small lender.

1. Flexible Lending Practices

If a big bank turns down your mortgage application, don’t assume you can’t qualify at this time. Large banks have tighter lending guidelines, and they typically prefer applicants with ideal circumstances. This can be a problem if you are self-employed, buying a unique property or need a specialized mortgage.
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Pros of a Biweekly Mortgage Loan

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There’s no one-size-fits-all mortgage loan. You have the freedom to select the mortgage term, the type of mortgage product, and you can even choose between a fixed-rate or an adjustable-rate mortgage. The choices, however, don’t stop here. It might come as a surprise, but some lenders allow borrowers to choose the frequency of their mortgage payments. Mortgage payments are typically due on the first of every month, but you might have the option of biweekly payments.

A biweekly mortgage plan requires a mortgage payment every two weeks. It’s not the full mortgage payment, but rather half payments. Understandably, you may prefer not to think about your mortgage multiple times in a given month—but this plan does have its advantages.
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Qualifying for a Mortgage If You Are Self-Employed

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Getting a mortgage has become harder for everyone due to tighter lending requirements—but if you are self-employed, you have a unique challenge ahead of you.

Freelancers, independent contractors and other self-employed workers don’t receive a W-2 from an employer. Instead, they rely on stated income on their tax returns to determine eligibility for a mortgage. Their income can be irregular and fluctuate from week-to-week, so they’re often classified as high-risk borrowers.

Being self-employed doesn’t mean you’ll never be able to buy a home. The trick is understanding what lenders require from you.
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How to Get Your Credit Mortgage-Ready

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You may be financially ready to purchase a home, but buying a house requires more than income. You also need acceptable credit.

Your credit score tells a lender a lot about your credit habits and, unfortunately, a bank isn’t going to give you a mortgage if you have unresolved credit problems. The good news is that you can fix your credit. So, while you may not qualify for a mortgage today, you can qualify in the future!

Here are three strategies to get your credit mortgage-ready.
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What to Expect in the Mortgage Loan Process

The mortgage loan process can be very overwhelming if you don’t know what to expect. It’s an intense process that takes a very close look into your finances. Fortunately, the process isn’t a secret. If you know what’s going to happen ahead of time, you can be prepared with all the necessary documents and information. The loan process and move ahead smoothly and in a few weeks, you’ll be moving into your new home.

Application Form

At the start of the mortgage application process, you’ll complete a paper application that requests some basic information about you, your income, employment, monthly expenses, and the house you want to buy. The lender will ask a lot of questions about your current financial condition. These questions are aimed to figure out how much you can afford to pay for a mortgage each month. Continue reading →

How Mortgage Loan Modification Works

One of the ways lenders are helping homeowners keep their homes is through loan modification. This is a process in which the terms of your mortgage loan are modified to make your payments easier. It’s not refinancing because you don’t get a new loan, but the goal is to reduce your payments so you can afford them.

The Federal government has a Home Affordable Modification program in which lenders can voluntarily participate. If you meet certain criteria, you may be able to take advantage of the program. Continue reading →

Job Change Bad Business for Mortgage Loan Applications

When you apply for a mortgage loan, a large factor up for lender consideration is the applicant’s income and job stability. You may think it is a wise choice to take that higher income-earning job before you buy a new home but you’d be wrong.

Switching employers or becoming an entrepreneur before or during your mortgage loan application and process could be detrimental to your approval from lenders. Mortgage underwrites look differently upon applicants who make a job change because essentially it changes income levels, which may prove to be a larger risk for defaults. Continue reading →

Wise or Foolish: Carrying a Mortgage Into Retirement

Ahh…retirement. It’s a time most working people look forward to, especially toward the end of their careers. A comfortable retirement requires you to take care of your finances ahead of time. That may mean paying off your mortgage loan before you go into retirement.

Advantages of Paying Your Mortgage Pre-Retirement

You can never know how much money you need to have in retirement because you don’t know how long you’ll live. If you can manage to pay off your mortgage before you retire, you’ll have one less expense to worry about once you retire. And since a mortgage is a pretty big expense, you’ll have taken a lot off your plate. Continue reading →

Reverse Mortgage Basics

A reverse mortgage can be used as a source of income during retirement. It’s like a home equity loan, only the money doesn’t have to be repaid except in certain circumstances. You remain the owner of your home and the reverse mortgage lender sends you money.

How to Qualify

To qualify for a reverse mortgage, you must be at least 62 years old. The house that you get the reverse mortgage for must be your primary residence, meaning that’s where you live most the year. If you pass away, sell the home, or permanently move somewhere else, that’s when the reverse mortgage loan becomes due. At the time of death, your heirs or your estate will be responsible for paying back the reverse mortgage. Continue reading →

4 Reasons a Refinance Might Make Sense For You

When homeowners consider a refinance, they usually do it for one main reason – to lower a mortgage payment. A mortgage refinance is the act of securing a new loan on your existing mortgage balance, often at a lower rate and different terms. A refinance makes the most sense if you are in a good financial position, have good credit, and can meet the criteria of the lender.

The new loan and terms typically provide some relief from the cost of a mortgage payment. With lower interest rates and a lower balance to finance, you can save quite a bit of cash each month on your new mortgage note. With low rates still available, more people are taking the steps towards a refinance. But did you know there are other benefits from refinancing your mortgage? Continue reading →