I often get the question “Do I need a pre-approval to buy a home?” If you aren’t paying cash, then yes…yes you do. Why would any seller take their property off the market if they didn’t know if their buyer was approved or not.
Don’t be confused, however, between “preapproval” and “prequalification.” They are two very different things.
At its core, lenders underwrite (do their due diligence to make a yes or no decision) a loan based on the “Three C’s” of credit – Credit (sometimes known as Character), Capacity, and Collateral. The collateral part has nothing to do with the borrower. It’s the study of the chain of title and the appraisal of the property. The other two C’s, however, are underwriting you, the borrower.
During a “Prequalification”, a lender checks on the first of the three C’s – Credit. They will take a basic application from the borrower and pull a credit report. Based nothing more than the application and the credit report, they might issue a “Prequalification” that tells potential sellers that the buyer has credit sufficient to issue an approval.
A “Preapproval”, however, goes a step further. It not only takes into account the first C, Credit, but it also verifies the second C, Capacity. Capacity is the borrower’s ability to pay back the loan. During this process, the lender will not only take the steps for “prequalification”, but they will also request income documentation such as taxes, W-2 forms, paystubs, bank statements, and other documents that will verify the borrowers capacity…or ability to pay.
Although novice real estate agents and sellers might accept a Prequalification letter prior to entering into a contract, most savvy realtors and sellers will want the Pre-Approval before pulling a property from the market.