If you're looking to buy a home, you probably know that you'll need to get a mortgage. But, in order to get a mortgage, at the very least, you'll need to get pre-qualified. However, what you may not know, is that there are actually more options beyond that with mortgage pre-approval and even pre-underwriting.
If you’re confused about what these terms mean and what the differences between them are, you’re in luck. We’ve laid out each one below with its advantages, disadvantages, and when it makes sense to do what:
What is a pre-qualification letter?
You’ve probably heard commercials on TV bragging about a lender’s ability to give you a pre-qualification letter in a matter of minutes. While this may be true, it isn’t worth much. A pre-qualification letter -- which states how much you’d be approved to borrow based on your own estimation of you income, debts, and assets -- isn’t used very often anymore in real estate.
Unfortunately, in today’s market, this letter doesn’t carry much weight. Since it’s solely based off of your own estimation of your income, debts, and assets, there’s no way for the seller to verify that the information you’ve provided is true. This provides very little reassurance to the seller that you’ll actually be able to actually buy a home.
Putting together an offer with only a pre-qualification letter attached gives you very little bargaining power. In very competitive markets, a seller might not even look at offers with only pre-qualification letters attached. However, in a pinch, a pre-qualification can help to indicate your interest while you wait to get pre-approved. If you’re serious about buying the home, take the process a step further, and get a pre-approval letter.
So, what is a pre-approval letter?
These days, getting a pre-approval is considered to be the first step to buying a home & is the standard for serious house hunters. Many sellers consider taking this step to be worth more than simply getting pre-qualified because, in this case, you need to provide financial documentation in order to receive a letter.
In order to receive a pre-approval, you should be prepared to give your lender the following financial documentation:
- Two years of W-2’s or high-net tax returns: These are meant to show that you have a stable work history.
- A recent pay stub with your year-to-date income listed: This is used to verify your ongoing income.
- Recent bank statements and any assets like 401Ks or IRAs: Mortgage companies use this to get a sense of your total net worth.
- All your debt records such as credit card statements or car payments: Finally, this helps to give the lender a sense of your total debt.
Once the lender has had a chance to review these documents, he or she will issue you a letter stating the maximum amount for which you can be granted a loan.
It’s important to note that a pre-approval letter is not a guarantee of a loan. If you decide to go with that lender, your loan will still have to go through underwriting, or the process of officially vetting your financials and determining the risk in granting you a loan.
What is pre-underwriting?
The most thorough process of them all is called pre-underwriting. This process -- also known as a “fully-underwritten pre-approval” -- takes financial verification even one step further. Instead of someone from the mortgage company simply looking through your financial documentation and issuing a credit check, the mortgage company actually vets your financials and determines the risk associated with granting you a loan.
If the underwriter signs off on your application, that means that you are guaranteed a loan unconditionally. As a buyer, this means you have the freedom to go without a loan contingency, which would typically allow you to back out of the deal in the event that you’re not approved for a loan. Since you’ve already taken care of that step by pre-underwriting, you won’t have to worry about that unfortunate occurrence, which will also make your offer more lucrative in sellers' eyes.
As we’ve talked about before, fewer contingencies make a stronger offer. It may even put you on par with cash offers, which is why pre-underwriting is often used in highly competitive markets. If you decide to go this route, just be sure to opt for a lender who has experience with pre-underwriting.