What's the difference between getting prequalified and preapproved for a mortgage? If you're planning to buy a home, you may have been told you should do one or the other, but be aware that they are not the same thing.
Basically, the difference is that a preapproval gives you a much more reliable idea of how much you can borrow and at what interest rate. A prequalification is more of an informal estimate you can use while checking out the housing market.
Just because a preapproval gives you a more reliable figure doesn't mean that's what you should run out and get. Both have their own advantages and which one you use depends largely on what point you're at in shopping for a home.
Prequalification: A first step
A prequalification is a more informal arrangement. You verbally provide the lender with information on your income, debts, assets, size of the down payment you can make and an estimate of where your credit stands. The lender takes all this into account and gives you a rough estimate of the size of the loan you can probably qualify for.
The advantage of a prequalification is that it's very quick and easy, and it doesn't cost you anything. You then use the figure you've been given as a guide when shopping for a home.
Preapproval: Ready to make an offer
A preapproval means you're getting more serious. For a preapproval, you need to document your income, debts and assets, and let the lender run a credit check as well. You may have to pay a fee for this service. In return, the lender will provide you with a written document stating exactly how much they are willing to lend you and possibly stating the rate as well.
A preapproval letter is a tool for negotiating the actual purchase of a home. It shows the seller that you are serious about buying and that you have a lender lined up who's willing to loan you the money. This makes you a more attractive prospect than a competing offer from a buyer who hasn't been preapproved, and tells the seller you've already got the ball rolling - meaning a shorter time to closing.
Should you lock your rate?
When getting a preapproval, you may request a rate lock at the same time, particularly if you're concerned rates could move higher in the immediate future. A rate lock means the lender guarantees to give you a specific mortgage rate, even if market rates go higher, provided the loan is closed within a certain length of time, usually 30 to 60 days. There's often a fee charged for a lock.
The problem with locking a rate on a preapproval is that if the seller rejects your offer or if you spend a week or so haggling over the purchase terms, the clock is ticking on your lock. If the offer falls through completely, you've got a rate lock on a mortgage but no house to buy. And the lock may well expire before you find and can close on another suitable property. For this reason, you may wish to wait until after you offer is accepted to lock your rate.
Closing the deal
An important thing to note is that neither a prequalification or a preapproval commits the lender to actually approving your loan application. That's because there's more than goes into approving a home loan than verifying your credit and finances - the home you're buying must also pass inspections, be appraised at a sufficient value to support the mortgage and have a clean title, among other things. But once those are completed and the legal documents are in order, the loan can be closed and your purchase completed.