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With the Housing Market as competitive as it is today, the buyer has huge advantages over the seller. But even with the huge advantages, they should understand the difference between being ‘pre-approved for a loan and being ‘pre-qualified for one. With the Fed lowering the rate by .25%, the mortgage companies are beginning to again offer new loans, specifically targeting those with Adjustable Rate Mortgages

(ARM’s) and Reverse Equity Mortgages to move to a fixed-rate mortgage. Advertisements are appearing like mushrooms after a spring rain, touting “You can be pre-qualified in 10 min.” and “We can pre-approve you for the home of your dreams.”

So, what’s the difference?

Here’s the definitions of pre-qualification and pre-approval:

• Pre-qualification: Pre-qualification is an estimate of how much you can afford to pay for a home based on your stated income, recurring debt, and any other factors/information you provide.
• Pre-approval: Pre-approval is a written commitment from a lender to finance your home purchase up to a set amount. The lender or bank has done a background and credit check, and has calculated the maximum amount they believe you can afford on any home loan.

One is only an estimate of how much your home should cost, while the other is a (temporary) loan offer up to a set amount.

The Pre-Qualification

There are a number of web sites that can give you pre-qualification estimates. Depending on various factors such as; Income, Interest Rate, Down Payment, Total Monthly Debt, and Home Price (to do a reverse qualification, giving you the amount of income, debt or down payment you’d need for a home of that price). None of these calculations are a firm offer from the bank, so they can’t be used as a lever to help with the purchase of the home. You must still get approved for a loan prior to either buying or offering to buy a house.

Pre-qualification formulas differ from lender to lender, and web-site to web-site. A ‘rule of thumb’ estimate is that the entire home price should be no more than three times your Gross Income.

Total Home Price <= Gross Income * 3

Additionally, assuming you fit into this formula, the total Debt to Income Ratio should be less than 33%. This means that of the net income you have, all debts (excluding the mortgage itself) should add up to less than 1//3^rd of the total.

Total Non-Mortgage Monthly Debt <= Total Net Income / 3

These are conservatively the MAXIMUM amounts you should consider for housing, based on your income and bills. Many personal investment counselors even consider THESE to be too high.

The Pre-Approval

Mortgage companies offer a pre-approval process to allow their borrowers some leverage when making an offer on a house. By getting pre-approved for a certain amount. The buyer can offer a (possibly) lower price for a house, but with a guaranteed loan attached. With the market like it is now, many home sellers go with the guaranteed lower price (‘a bird in the hand’) than take the risk of losing the sale through accepting a higher bid, but have the contract fall through because the buyer couldn’t get the financing they planned on (the ‘two in the bush’)

The Mortgage companies perform their own pre-qualification (as above) and verify income, credit history, and then apply their own risk management/mitigation guidelines to decide whether they should offer the loan. The loan itself isn’t for a particular property, but is based on the assessed value of the home that the offer is (eventually) made on. If the house is less expensive, the pre-approved loan covers it completely. if not, the buyer either has to come up with the difference or go through the whole approval process again.

Buying Strategy

Being pre-approved is only one strategy for getting the best price on your new home, but its one of the easiest and safest first-steps for the home buyer.

Having the bank pre-approve you, at a minimum shows that the bank believes you to have the right ratio of debt, income, and credit history to be a good credit risk.

Tags: prequalify, preapprove, mortgage, housing

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