In many markets, sellers expect an offer to come with a letter from a lender. That letter is usually called a preapproval, sometimes a prequalification. It tells the seller that a lender has looked at your finances and is generally willing to lend you up to a certain amount. For you, it does something just as useful: it turns a guess about your budget into a number tied to your actual credit and income.
Prequalification or preapproval: does the word matter?
Less than you might think. The Consumer Financial Protection Bureau points out that lenders use the two terms differently. Some give a prequalification based on information you report without checking it, and a preapproval only after verifying documents. Others use the words the other way around or interchangeably. Both describe a letter saying the lender is generally willing to lend up to a certain amount based on certain assumptions. Neither is a guaranteed loan offer.
What matters is whether the letter is strong enough for sellers where you are buying. A local real estate agent or a housing counselor can tell you what sellers in your area expect to see.
What lenders usually ask for
- Proof of income, such as recent pay stubs, W-2s or tax returns if you are self-employed.
- Bank and investment statements showing your down payment and reserves.
- Information about your debts, which the lender checks against your credit report.
- Identification and permission to pull your credit.
A letter based on verified documents carries more weight than one based on what you typed into a form. If you can, give the lender the full picture up front so the amount in the letter does not shrink later.
Why getting it early pays off
Many people wait until they are ready to tour homes. The CFPB suggests another view: getting preapproved earlier can reveal problems with your credit while there is still time to correct them. An error on your credit report, a forgotten account in collections or a high card balance is much easier to deal with months before you make an offer than in the middle of one.
Tip: If a lender evaluates you and says you do not qualify for a letter, it must send an adverse action notice even if you never filed a formal application. Read it: it tells you the main reasons.
Talk to more than one lender
Rates and fees differ between lenders, and so do the loan programs they offer. Talking to several lenders lets you compare. Once you formally apply, each lender must give you a Loan Estimate within three business days, on the same standard form. That makes it straightforward to put offers side by side and see the differences in rate, monthly payment and closing costs. Our guide to Closing Costs Explained for First-Time Buyers explains how to read them.
Questions to ask each lender
- Which loan programs fit my down payment and credit?
- Is your letter based on verified documents?
- How long is the letter good for, and what could change the amount?
- What would my total cash to close look like at this price?
- Do you charge points, and what would the rate be without them?
Keep your finances steady after the letter
A preapproval is a snapshot. The lender will check again before closing, and changes in between can shrink or cancel the loan. Until you have the keys, avoid opening new credit, financing a car or furniture, changing jobs if you can help it, and moving large sums of money without a paper trail. If something does change, tell your lender early.
How the letter fits into your offer
Your agent will usually attach the letter to your offer. Some buyers ask the lender for a letter written for the exact offer price, so a seller does not see the full amount you are approved for. That can be a smart negotiating move. Pair the letter with a financing contingency in the contract, which protects your earnest money if the loan falls through for reasons outside your control. See How to Make an Offer on a House: Price, Earnest Money and Contingencies.
If the amount is lower than you hoped
A lower letter is not a dead end. You can pay down a debt to improve your debt-to-income ratio, add to your down payment, look at a different loan program or adjust your search. Sometimes it is also a useful reality check: the number you hoped for may have been more than your monthly budget could comfortably carry. Our guide on How Much House Can I Afford? A Budget That Starts With the Monthly Payment helps you set a price range you can live with.