The Importance of Preapprovals

The Importance of Preapprovals

The Mortgage Industry Jargons

From the outside looking in, the mortgage industry sure has its fair share of jargon. Of course, most every business does have its own internal jargon, but the mortgage business does come up with some foreign language at times. And let’s not forget all the acronyms. PITI? DTI? Sometimes these very terms sound familiar but they’re quite different. PITI is the acronym for principal, interest, taxes and insurance and is stands for the monthly mortgage payment while DTI stands for debt-to-income ratio and compares monthly credit payments with gross monthly income. PITI and DTI sound very similar but they represent two different aspects of the mortgage process. Perhaps one of the most commonly confused terms are “prequalification” and “preapproval.”

They too sound very much the same but while they’re close they’re certainly not the same. And when it comes to shopping for a home and making an offer it could mean the difference between having your offer accepted or losing the house to someone else.

How so?

Let’s first look at a prequalification. The term “qualified” means someone has the ability to obtain a mortgage. The “pre” part looks at before the approval actually occurs. A prequalification starts out with a general conversation with an experienced loan officer. This conversation can take place face to face with the loan officer or even over the phone. The loan officer will ask a series of questions that will provide a general sense of the likelihood of an approval as well as a qualifying loan amount.

1.  Employment History
Employment History

The loan officer will want to know about your job. What do you do for a living? How long have you been doing that and how long have you been with your current employer? General loan guidelines require an employment history of at least two years, full time. Part time employment can also be used as long as a two year history exists and the lender can determine the part time income will continue into the future. Getting prequalified means telling the loan officer how much you make each month.

This is a gross income amount and not your take-home pay. If you get a regular bonus, say a quarterly performance bonus, that income may also be used under the same two year requirement. If you’re self-employed you’ll need to provide your lender with an approximate net monthly income.

2.Prequalification AmountPrequalification Amount

What sort of payments are made each month? Do you have a car payment? Student loan payments? Whatever would appear on a credit report as a monthly credit obligation will be factored into your prequalification amount. Utility bills and every day living expenses are not part of this equation. Neither are monthly installment payments that have less than 10 months remaining. If a car you own has say six months left before it’s all yours to own free and clear, the car payment isn’t included.

3.  Available Funds to Finance a Home
Available Funds to Finance a Home

How much funds do you have available to buy and finance a home? You’ll need a down payment, unless you’re eligible for a VA loan which requires zero down, of at least 3.5% of the sales price. 3.5% is the minimum amount for an FHA loan. For a conventional loan, the minimum down payment is 5.0%. You’ll also need funds to take care of closing costs as well as well as money left over. These left over funds are called “cash reserves” and generally counted as the number of months of mortgage payments you have available to you once the loan closes. Most programs like to see at least six months of cash reserves in order to qualify, but lenders have a bit of flexibility with this guideline.

4.  Good Credit History
Good Credit History

You’ll need to have a pretty good sense of your credit standing. Generally, if you’ve made your monthly credit card and car payments on time your credit is in good shape. If you’ve made any recent payments more than 30 days past the due date, that will affect your credit history. Most people have a good idea regarding what their credit report looks like.


After answering these questions and a few others, the lender then presents a series of loan programs you can review. The loan officer will take a look at prevailing mortgage rates and given your income and debts, provide a qualifying loan amount. You’re not prequalified. But that may not be enough when you make an offer on a home.

You see, a prequalification is nothing more than a conversation. Nothing is verified as the loan officer simply takes someone’s word how much they make, their credit and how much money they have available. Today, sellers want to see a higher grade of qualification. They want to see a preapproval.

You see, a prequalification is nothing more than a conversation. Nothing is verified as the loan officer simply takes someone’s word how much they make, their credit and how much money they have available. Today, sellers want to see a higher grade of qualification. They want to see a preapproval.


A preapproval goes through very much the same process as it relates to income, employment, cash to close and credit history. Only the preapproval actually verifies via third parties the information provided. A preapproval requires the borrower to complete a loan application and give the lender permission to pull a credit report. A preapproval means providing copies of your last two years of federal income tax returns. You’ll need to make copies of your most recent bank statements from the accounts used to close on the transaction. The lender reviews your credit report as well as qualifying credit scores.

Taking these extra steps can bolster your offer compared to someone with just a prequalification or someone who has not yet spoken with a lender but still shopping for a home. When you make an offer on a home the seller wants to see a letter from a mortgage company showing that you have submitted a loan application. This tells the sellers that you’re serious about this process and not just shopping around. The preapproval will state that income has been verified and you have enough funds to close on the transaction. It will also show that the lender has reviewed your credit report. What it won’t say is how much you qualify for, only you and your loan officer are privy to that information.

A preapproval is a bit of peace of mind for the sellers. The sellers know that you’ve taken all the necessary steps and all that’s needed is a signed sales contract. Without a preapproval, the sellers are taking a risk, not knowing if the buyers can in fact obtain financing. When sellers accept an offer, the home goes into a “pending” status and fewer real estate agents will show that home knowing it’s just a matter of time before the home is sold to someone else. Even if your offer is a bit lower than a competing one, if you have a preapproval letter and the other offer does not, sellers will likely accept the security of a preapproval letter over an offer without one.

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