Difference between Loan pre-qualification and loan pre-approval

What is the difference between getting pre-qualified or pre-approved for a home loan? Both involve some level of submitting documentation to a lender and pulling a credit report.  Both are also an acceptable way to proceed with buying a home, but is one better than the other?

Yes, one option may actually be the best for you depending on your situation and timeline.  Below are some details on what’s involved with each option.  Watch my video on the topic or read below.

Pre-Qualification

When getting pre-qualified for a home loan in San Jose, financial details and documents will be discussed and reviewed. The level of detail and documents required for this step will vary from one lender to the next. Even within the same bank/lender, the process may vary from one Loan Officer to the next.

Some Loan Officers simply take a loan application over the phone or internet and issue a pre-qualification letter based on information provided by the borrower.  Your pre-qualification is not as thorough with this method since it is based on stated numbers without an understanding of the buyer's entire financial picture.

Other Loan Officers process applications with more depth and detail.  These Loan Officer may require supporting documentation before issuing a pre-qualification letter.

A true pre-qualification letter involves the Loan Officer gathering necessary documentation and then running an automated underwriting engine (AKA Desktop Underwriting).  The underwriting engine can issue an automated underwriting approval.

Steps for an accurate Pre-qualification

Here are the complete and accurate steps to take for a real loan pre-qualification:

1. Discuss with the Loan Officer on phone or in person your buying goals and potential loan options for the purchase.
2. Submit a loan application (either in person, over the phone, or using an online loan application tool).
3. The lender pulls a credit report of all buyers who intend to be on the loan. (This is a hard inquiry and does affect the buyer’s credit score, although it’s a minimal affect.)
4. Turn in all supporting documentation (such as pay stubs, W2s, tax returns, asset statements, etc) to the Loan Officer.
5. Loan Officer reviews supporting documentation and calculates the buyer’s income and assets.  This calculation applies the Loan Officer's knowledge of lending guidelines to confirm accurate numbers are used. (Be aware some loan agents are more sales-oriented verses detail-orientated.)
6. Loan Officer runs the automated underwriting engine and if they receive an approval, they issue the Pre-Qualification Letter.
7. Now the buyer is ready to start making offers to buy a home.

The bottom line is during the pre-qualification process, the file will remain on the desk of the Loan Officer.  Because its remaining with the Loan Officer, the turn time to get a pre-qualification done can be very fast - even same day if necessary.

Word of Caution about Pre-Qualifications

As you may surmise from the above process, the Pre-Qualification letter is only as accurate as the Loan Officer that reviewed the documents and ran the underwriting engine.  There is a variance in skill set from one loan agent to the next.  Skill sets vary in terms of knowing loan guidelines, calculating income correctly, and looking for any potential red flags.  Make sure you are working with an experienced Loan Officer who knows their guidelines extremely well. Ask the Loan Officer questions to see how knowledgeable they are. Using your real estate agent’s recommendation on loan officer is highly recommended since your agent has experience with many loan officers and knows which ones are accurate and thorough.

Pre-approval

Getting a loan pre-approval would be the next step in the process after the initial pre-qualification is complete.  The main difference between pre-qualification and pre-approval is the loan moves out from the Loan Officer’s desk.  The loan file will be submitted to the bank for underwriting by a live underwriter.

For a clean and faster approval, a complete file is needed to submit to underwriting. Additional steps for the buyer in this process may be the following:

• Write letters of explanation on their income, assets, credit, job history, etc.
• Verify they have paid rent on time for the past 12 months
• Verification of employment from the buyer’s employer

The requirements for this step will vary from one loan scenario to the next. So working with the Loan Officer to provide a complete package to underwriting is key to getting a clean loan approval.

Why Get Pre-Approved?

Taking this next step to get pre-approved will benefit you when making offers on a property. With the loan paperwork complete ahead of time, the buyer will:

1. Have confidence in their purchase amount.
2. Be able to close escrow more quickly and in the most efficient way possible.
3. Stand out against other offers. Pre-approved and underwritten buyers are typically perceived to be stronger offers in the minds of the listing agent and sellers.  Sometimes subtle differences increase chances of your offer acceptance so its nice to have this option.
4. Ahead of an offer, address any underwriting questions on the income, assets, or credit.  If a buyer has a large variance in income from one year to the next, or any other potential red flag identified by their Loan Officer, this is an especially beneficial step to take.  The risk of these variances can be removed with full underwritten pre-approval.

Why Wouldn’t You Get Pre-Approved?

One drawback of getting full underwriting approval is the timeline. As explained above, the buyer and loan officer must do quite a bit of work ahead of making an offer. For true pre-approval, the buyer and loan officer must package up a complete file, sign loan disclosures, gather 3^rd party verifications, and then wait in the underwriting queue for the file to be reviewed by a live underwriter.

Typically pre-approval files, without a property associated with them yet, have a lower priority in the underwriting queue. Turn times for "no-property pre-approvals" can vary from one to four weeks depending on the bank’s volume at the time.

It is possible to get pre-qualified initially and use that letter to make offers while waiting for underwriting to be done for the pre-approval.  Once the file is fully underwriting-approved, a letter stating the buyer is pre-approved can be issued and submitted with offers to buy a property.

Buyer Beware

Buyer’s be aware that several lenders and brokers will issue a “pre-approval letter” without submitting the file to underwriting by a real-person underwriter.  They will run the automated underwriting engine mentioned in the pre-qualification step above and say the loan is “pre-approved”.

To understand potential risks, buyers should ask their lender if they are actually submitting the file to be reviewed by a live underwriter. Also confirm the reviewer is the same underwriter who will work on the file once an offer is accepted to purchase a property.

How long is the pre-qualification or pre-approval good for?

Both pre-qualification letters and pre-approval letters are typically good for 120 days.  After the 120 days expire, a new credit report would need to be pulled and updated documentation must be provided by the buyer.

Which loan approval is best for you?

Depending on the buyer’s available loan scenarios, one option may be more beneficial than the other.  Discuss with your real estate agent which loan approval option is best for your timeline and the current market conditions.

To recap:

Pre-Qualification 

• Buyer submits a loan application, credit report, and supporting documentation
• Loan Officer runs an automated underwriting engine and issues a Pre-Qualification Letter (Turn time is 1 to 3 days typically)
• The buyer is ready to make offers with a pre-qualification letter in hand. 

Pre-Approval 

Same steps as above in Pre-Qualification plus:

• The buyer's loan file is officially submitted to underwriting to be reviewed by a live underwriter. The turn time can be anywhere from 1 to 4 weeks depending on the bank's current loan processing volume.
• Benefits of pre-approval letter:
  • Can typically close escrow on a property more quickly
  • If buyer's offer terms are close with competing buyers on a property, then listing agents may give priority to buyers who have fully underwritten approval.

To understand the steps to Buy a Home, read my blog post on this topic.