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You wouldn't go on a shopping spree with nothing but a checkbook and no idea of how much money is in your account. For first-time home buyers, shopping for a home without getting preapproved (or at least prequalified) amounts to the same thing. It's hard to shop for something when you don't know what you can afford.
To prequalify, you give a loan officer information about your income and finances. Based on that information (without checking it), the loan officer estimates how much you can afford to borrow. Because prequalification is an informal process, without verification of the information you submit, it's not binding on the lender - in other words, there's no guarantee that the lender will approve the amount for which you've prequalified when you formally apply for a mortgage. But prequalification doesn't cost anything, and it gives you a ballpark idea of what you can afford.
Getting preapproved is a lengthier process that takes a closer look at your finances. When you apply for preapproval, the lender verifies the financial information you give - info about your employment, cash on hand, credit, debt, and so on - and gives you a letter that specifies the maximum loan amount you qualify for. To get preapproved, you may have to pay a fee, and the lender will check all the information you submit. But preapproval is the lender's guarantee that, as long as you don't make any drastic changes to your financial picture (such as losing your job or taking out a large loan), you can get a mortgage up to the stated amount.
Both prequalification and preapproval give you an idea of your price range when shopping for a home. The difference is in the level of commitment: prequalification is a "maybe"; preapproval is a "yes."
Preapproval offers some real advantages to home buyers:
- It shows you mean business. If a seller is deciding among multiple offers, a preapproval letter carries some weight, especially if the seller is in a hurry to sell. Preapproval means that the seller won't encounter a nasty surprise when the chosen buyer can't qualify for a mortgage.
- You can shop realistically. When you're preapproved, you won't waste time looking at homes outside of your price range - and that can save you the heartache of falling in love with a house, only to find out later that you can't afford it.
- It can speed up the closing process. Because your financial information is already verified, closing can happen faster than if you hadn't been preapproved. You'll still have to get the home appraised and inspected, but you can shave a couple of weeks off the mortgage processing time.
For most house hunters, preapproval is a great idea. But if you decide to get preapproved, keep these issues in mind:
- Preapproval isn't forever. Your preapproval letter expires after a set period of time, often 90 days. If you're still shopping after that, you have to get the letter updated. If your financial situation changes, your preapproval amount may change, too.
- You've been approved, but the property may not be. Before a lender gives you a loan, you have to get an independent appraisal to confirm the home's value. If the lender determines that you've offered more than the home is worth, you may not get the loan - even though the purchase price is within your preapproved range.
- Preapproval specifies a maximum loan amount. Just because the bank has approved you up to a certain amount doesn't mean you should apply for the maximum. You get preapproved for the amount the lender determines you can afford, but you may not be comfortable paying that amount. Keep in mind other expenses associated with home ownership and don't stretch yourself to the limit just because the lender said you could afford it.
