Differences Between Pre-Qualification, Pre-Approval, Loan Commitment

It's important to get pre-approved for a mortgage before you shop for a home, but sometimes the terminology is confusing. Do you understand the differences between the terms pre-qualified, pre-approval and loan commitment? The differences can affect your home buying transaction.

Some real estate agents are confused by the terminology, so it's no wonder that home buyers and sellers are, too. Although they are related, the three terms each signify a different level of approval from a lender.

Pre-Qualified, Pre-Qualification

Loan pre-qualification does not typically include an analysis of your credit report or an in-depth look at your true ability to buy a home.

You can be pre-qualified by a lender, by a real estate agent or you can do it yourself. The term means that someone has taken a general look at your income and expenses and plugged them in to a debt-to-income ratio formula.

Pre-qualifying yourself before you start looking for a home gives you a general idea of the price range you can afford.

It will not nail-down an interest rate for you, and that factor and others affect the monthly payments a bank will allow you to make.

When you are pre-approved for a mortgage, it means a lender has looked closely at both your credit report and your income and determined that you qualify for a loan. The lender will tell you the maximum amount of loan it will make, which loan programs you qualify for, and will discuss the interest rates it will offer for different types of loans.

When you're pre-approved you can go shopping for a home with confidence about your buying power, but it still isn't a guarantee that the lender will approve the loan.

Loan Commitment

A lender issues a loan commitment after it has approved both the house and you. A home appraisal must meet the lender's guidelines, which usually includes a stipulation that the home must appraise at or higher than the sales price.

Price is just one aspect of the home the bank considers. They might want to make sure the appraiser thinks the property will sell within a reasonable amount of time--in case you don't make payments and they must foreclose. An FHA appraisal is even more detailed than appraisals required for a conventional loan.

A comment from the appraiser such as "observed a crack in the foundation and basement appears wet," will raise a red flag to the lender that a structural inspection is needed.

If the bank reads "home accessible only with a 4-wheel drive vehicle," you can be sure they'll want to know more about ongoing road maintenance. Where I work, we have thousands of mountain roads that are maintained by groups of home owners. Many lenders verify that a signed and recorded road maintenance agreement is in effect before approving the loan. Other banks don't seem to care as long as no derogatory comments are made about the road.

Every area has its own issues. Your real estate agent should be able to advise you about potential problems that could affect your purchase.

Other Requirements for Commitment

• A title search must show that the home's title is cloud-free, meaning there are no problems associated with it such as outstanding liens that can't be paid at closing, right-of-way issues, pending lawsuits, etc.
• Your credit report might be checked again before closing to make sure it hasn't changed in a negative way.
• You will be asked to show proof that the home will be insured as soon as ownership transfers to you. A flood certification document might be required. The lender might also ask to see other types of documents.

The loan commitment letter is issued only when the bank is sure it will lend, so if you must put a loan commitment date on your offer to purchase be sure it provides plenty of time for the bank's requirements. If a commitment date is a part of your contract, the home seller can demand to see written proof that your lender has issued it as soon as the date has passed. Question anyone who tries to insert an early commitment date in your contract.

Terminology Differences

Since terminology sometimes differs in different regions, ask your lender to explain all of the terms associated with their mortgage approval process.