What does it mean to prequalify for a home loan?

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Reader question: “I’ve been told by a real estate agent that I should get pre-qualified for a mortgage, before I start shopping for a house. Is this true? What does it mean to prequalify for a home loan?”

You don’t have to get pre-qualified before house hunting, but it might help you to do so. You can also get pre-approved by a lender (I recommend the latter). It will benefit you in several ways. We will talk about the benefits in just a moment. But first, I want to explain the terminology we’re using here.

Pre-qualification — This is when a mortgage lender does a quick review of your income and debt levels, and tells you how much they might be willing to lend you. In some cases, you can prequalify for a home loan online or over the phone. There is usually no cost involved with pre-qualification.

Pre-approval — This is similar to the process described above, but it’s more in-depth. Here, the lender will review your credit report and take a closer look at your financial picture. They’ll also ask for more documentation to verify your financial situation. You might have to pay an application fee at this point, or at closing. The end result is the same, in that the lender will tell you what they are willing to lend you.

For practical purposes, it’s better to get pre-approved. When you prequalify for a home loan, the lender only takes a quick look at your finances. So the process is not a good measurement of where you stand, in terms of being approved for the loan.

Additionally, sellers and their real estate agents won’t take you seriously if you only prequalify for a mortgage loan. This could be a problem if you find yourself in a competitive, multiple-offer scenario with other buyers who have actually been pre-approved. Pre-approval is a stronger measurement of a borrower’s qualifications, when compared to prequalification.

But you asked how to prequalify for a home loan, let’s revisit that…

How to Prequalify for a Mortgage

It’s actually fairly simple to prequalify for a mortgage. Let me rephrase that. The process itself is easy, though that doesn’t necessarily mean you’ll be approved in the end. Prequalification can be done over the Internet, or by fax and email. You would simply call the lender or visit their website. Tell them you want to prequalify for a home loan, and they will take care of the rest. It’s their business, after all.

Here’s how the process usually works if you do it online:

1. You would fill out a short form on the lender’s website. This will include your name and contact info, the amount you want to borrow, the amount you have to put down, and the purpose of your home loan (purchase or refinance).
2. After you submit the form, you may be presented with some general information about interest rates and terms. But this is not a guarantee or commitment from the lender. You won’t know what rate you can get until you submit a complete application.
3. A representative from the bank will probably contact you, usually the same day or by the next business day. They will ask for additional information about your income and debts.
4. The lender will tell you roughly how much of a loan you could get, based on your income.
5. If you want to move forward with the process, you would then have to submit a complete mortgage application.

These are the basic steps to prequalify for a home loan. You can see that it’s not a very intensive process. It’s just a quick look by the lender, to see how much you might be able to borrow. Frankly, I feel that it’s a waste of time. Pre-approval provides a more in-depth review of your finances. So it’s more useful as an evaluation tool.

You also asked if mortgage pre-qualification was necessary. If you’re going to do either of these things, I would recommend the pre-approval process. It gives you a better idea how much you might get from the lender. It also gives you a leg up when making an offer to buy a home, because the seller will take you more seriously. This is particularly important in an active real estate market, where the seller might get more than one offer.

Most real estate agents prefer to work with buyers who have been pre-approved by a lender. Otherwise, they could end up wasting a lot of time on unqualified buyers.

Mortgage pre-approval will also help you identify problems that need fixing. For example, the lender might tell you that your credit score is too low for their standards, or that your debt level is too high. So at least you’ll know what to work on.

Qualification Criteria: Credit Score, Debt & Down Payment

Lenders will consider more than a dozen financial factors when you apply for a home. But the three biggest factors are your credit score, your debt-to-income ratio, and the amount of down payment you have. The last item might not be applicable in some cases. For example, if you’re using the VA home loan program, you might not need to make a down payment. Credit scores and debt ratios will be considered in every lending scenario.

[See: Minimum Credit Score for Mortgage Approval]

When you try to prequalify for a home loan, the lender may only consider your income and debt. After all, they’re not making a firm commitment at this point. So they don’t need to go too far into the weeds — not yet, anyway.

Debt-to-income ratios have become increasingly important over the last few years. Ever since the housing crash, lenders are paying more attention to the borrower’s debt ratios. This is a comparison between the amount of money you earn each month, and the amount you spend to cover your current debts. If you’re spending too much of your monthly income on debt obligations, you may not qualify for a mortgage loan.

[See: Why Debt-to-Income Ratios are Important]

Here are some key points to take away from this article. When you get pre-qualified for a mortgage loan, the lender will take a cursory look at your financial picture — particularly your income and debts. Based on this, they will tell you how much of a loan you might qualify for. The pre-approval process goes even further. This is when they start asking for documents to verify the information you have provided. You can prequalify for a home loan online, or by fax and phone. Personally, I recommend getting pre-approved because it’s more useful during the home-buying process.

This article answers the question: How do I prequalify for a home loan? If you have additional questions about the mortgage process, be sure to do a search at the top of this page. You’ll find a lot more articles like this one. Good luck with your home buying process!