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The perks of pre-approval
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September 5, 1999: 9:11 a.m. ET
Knowing what you can afford can make house hunting less arduous
By Staff Writer Nicole Jacoby
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NEW YORK (CNNfn) - There's probably no bigger disappointment for prospective home buyers than finding the house of their dreams only to discover they can't afford it.
A pre-approved loan can prevent such miscalculations by establishing in advance what is within your means.
"The first stop when you're shopping for a home should always be the lender," said Paul Reid, executive vice president of the Mortgage Bankers Association of America. "They will tell you how much home you can afford and you can look at the various financing techniques available."
Because interest and mortgage rates are now relatively low, the options available to home buyers are vast. One loan may be better than another depending on your situation.
A young couple, whose earning power is likely to increase over the years, may lean toward an adjustable rate, while a more established family may prefer a 15-year mortgage to ensure their home is paid off when their children reach college age.
Regardless of what type of loan you settle on, a pre-approval can be your strongest negotiating tool.
The pre-approval difference
Pre-approval is sometimes confused with pre-qualification. The two are similar, but pre-approval come with much stronger guarantees.
Loan applicants are pre-qualified after a cursory check by a bank or mortgage broker. The lender offers an estimate of what size loan a prospective home buyer will qualify for based on information the loan candidate supplies. But there are no assurance the bank will ultimately provide this loan, as information that surfaces during a more thorough check may disqualify you.
There is no charge for a pre-qualification, which can take a matter of hours, and the home buyer is in no way obligated to the lender providing the check.
Pre-approvals are somewhat more involved, with the mortgage broker taking the same steps as if you were applying for a real loan. Your credit history, employment information, investments, assets and liabilities will all be evaluated. The only missing link will be the appraisal of your prospective new home, since -- obviously -- you will not have chosen it yet. You may be charged for a pre-approval.
Like pre-qualifications, pre-approvals can happen very quickly, with many banks and online lenders completing the process in a matter of days. In some cases, a lender may even be willing to lock in an interest rate for you.
"Pre-qualifications are good, but it's like flying stand-by: You think you're going on. When you have a ticket (pre-approval), you know you'll fly," said Reid.
More importantly, pre-approvals keep home buyers from bidding on a home that is beyond their means. Many home shoppers set their hearts on a home they later find out they cannot afford because of unforeseen debt or other financial factors.
A boost in bargaining power
Pre-approvals can give prospective home buyers an edge in the real estate market.
"Houses sell quickly so you want to ensure your bid is the most attractive to the seller," said Toni Sherman, president of the Council of Residential Specialists. "Sellers know prospective buyers who hold a pre-approval are serious shoppers."
Many sellers are more willing to accept a secure bid over comparable -- or even higher -- bids. In some cases, sellers have been advised to only accept offers from buyers who have been pre-approved for their home loan, says Sherman.
In addition, a pre-approved loan can greatly bolster a home buyer's bargaining power. Since the seller no longer has to worry about whether you will qualify for a loan, he or she may become more flexible about other terms, including the price, the closing timeline or extras, such as appliances.
Closing the transaction also usually goes more quickly -- and more smoothly -- if you have been pre-approved. So sellers that are in a hurry to unload a property will welcome buyers who have been pre-approved.
Who benefits the most
Mortgage pre-approval is advantageous for almost all home shoppers, but for some applicants, there are particular benefits.
Because first-time buyers have no equity, for instance, they might be dismissed in favor of an experienced home owner, who the seller knows is accustomed to making mortgage payments. A pre-approval can level that playing field.
Freelancers and the self-employed may benefit from pre-approvals that improve their financial standing on paper. These workers often don't have the financial credentials of their more corporate counterparts because their incomes tend to fluctuate somewhat dramatically, a state that makes many lenders nervous. Pre-approvals can keep these types of workers in the game.
People who may be simultaneously buying and selling a home should also seriously consider a pre-approval. That's because many home sellers don't want the sale of their home to depend on the sale of someone else's.
The paperwork nitty-gritty
To get loan pre-approved, you will have to provide a wide range of personal financial information.
Your credit report will be the basis for any loan, so it is often a good idea to run a credit check on yourself before even setting foot in the bank to make sure there are no glaring problems.
You will also have to provide income statements, usually two years of W-2 forms or profit-and-loss statements, depending on whether you are self-employed or not. Income statements help the lender assess your buying power and potential risk.
One month of pay stubs and three months of bank statements, including checking, savings and other assets such as mutual funds, are also commonly requested. Lenders like to see that funds used for the down payment have been maintained over time and were not just recently acquired.
Finally, two years of tax returns will likely be required. Underwriters like to look for warning signs that could reveal unforeseen debt in the event of an audit.
Stamp of approval
Upon getting pre-approved, the lender will provide you with a written statement confirming your status.
The approval will most likely be expressed in terms of a monthly mortgage payment rather than a loan. Lenders are usually reluctant to commit to a full loan amount because interest rates can fluctuate and a rate hike may put a monthly payment beyond an applicant's means. In the event of a hike, an applicant would have to increase the down payment or buy a less costly home if a rate hike occurs.
The pre-approval also does not take into account the appraisal of the home you will eventually choose to purchase. Consequently, there is still a chance the mortgage could fall through.
"A lender will still need to look at property appraisals before a loan is approved," Sherman said. "Still, with a pre-approval, you will rest easier knowing exactly what you can afford and you will have confidence in the fact that you bring an attractive offer to the negotiating table." 
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