The terms pre-qualified and pre-approved almost sound like they could be synonyms. But when it comes to home financing, there's actually quite a big difference between the two—and securing pre-approval for a loan is actually what brings you closer to the closing table.
Think of it this way: Getting pre-qualified is like taking baby steps towards getting approved for a mortgage. You call up a lender, self-report your credit score, and relay information about your income. In turn, the lender gives you an idea of how much you can afford.
"The most basic difference is that a pre-qualification is usually based off of a quick verbal conversation about a buyer's financial situation. It's only as good as the buyer's honest answers," explains Andrew Fortune, owner and broker of GreatColoradoHomes.com. "A pre-approval is usually based off of financial documentation that confirms the buyer's answers. It's much more trustworthy."
Oftentimes, first-time homebuyers mistakenly believe that being pre-qualified and pre-approved are one in the same, Fortune says.
"If a lender tells a first-time buyer that they are pre-qualified, they sometimes will take that as a solid 'Yes, I can buy a house!,'" Fortune says. "It can be heartbreaking later when the lender checks to verify their debt and income documents and the buyer is not actually approved."
So, what exactly happens between the pre-qualified and pre-approved stages?
This is the time when you start gathering up all your required documentation, explains Brendan McKay, owner of McKay Mortgage Company, a mortgage brokerage in Bethesda, Maryland. A pre-approval happens after you've provided documents like pay stubs, bank statements, tax returns, and W2s, and the loan officer has combed over everything and given you the green light.
But, be forewarned: A few things can go awry between the pre-qualified and pre-approved stages.
For example, one mistake that people often make during pre-qualification is relying on third-party credit reports (those other than the official, once-a-year free report you can get from one of the three major bureaus at annualcreditreport.com), which are known to inflate scores, says Paul Wood, a licensed real estate salesperson in New York City.
"Many times the buyer will provide a free credit report, and the hard inquiry comes back lower," Wood has noticed. Also, he says, negative comments such as a "missed payment" tends to be weighed more heavily by the bank whereas it may not be a large portion of a credit report, Wood says.
Another rookie mistake? Opening up a store credit card to buy furniture or leasing a new car while you're simultaneously in the market for home financing. These moves can tie up your credit and tinker with your income-to-debt ratio.
"Purchasing any large items that can affect credit is a big 'no-no' when it comes to preparing to home shop," says Kim Howard, a real estate broker who, with her husband, founded Howard Homes Chicago.
Even before you get pre-qualified, you can get your financial house in order.
One year out is the perfect time frame to really start monitoring your credit, getting realistic about your down payment, and talking to a real estate professional to understand the process, Howard says. Go ahead and connect with a mortgage lender this far out, too, so that you can know what's expected. For example, understanding that your commission-based job could affect your buying power differently than a salary-based job will help you plan for the lending process, she says.
Also, before you apply for a home loan, you can start paying down the balances on your open credit cards, says Randall Yates, the founder and CEO of The Lenders Network, an online mortgage marketplace.
"The amount of available credit you're using makes up 30 percent of your overall credit score," Yates says. "Try to keep your balances less than 20 percent of your card's credit limit."
Also, when it comes to working with mortgage lenders during the pre-qualification process, honesty is the best policy. Peter Grabel, managing director of Luxury Mortgage Corp, says the goal is to close your loan as smoothly as possible. The best way to do that is avoid any surprises from popping up. Be upfront if you pay alimony, have a tax lien, received a financial gift from a family member or, heck, even have an outstanding parking ticket.
It's also important to understand that hiccups can arise even after the pre-approval process and underwriter review.
For example, while it's rare, if you lose your job or quit the week of closing, your approval could be in jeopardy, explains Grabel. Lenders always do a final "verification of employment" leading up to the closing.
The takeaway, here? Snagging that pre-qualification is just the first in many steps before you close on a house.