A pre-approval letter is a statement from a lender that you are qualified to service a specific amount of debt. If you are bidding on your dream home, being pre-approved can be a great advantage over competing bids. It can also let you know exactly where your price ceiling is. There is nothing more disappointing than falling in love with a home and then realizing it is out of your reach.
It is important to distinguish between pre-qualification and pre-approval. Pre-qualification merely requires that you provide some general information about your income and debt levels to a broker or lender. There is little or no confirmation of the information. As a result, a pre-qualification can give you an idea of price range and mortgage payments but it carries little weight when it comes to negotiating.
Pre-approval is also provided by a broker or lender but unlike the pre-qualification letter, the information must be verified. You will be asked for documentation about your income, the source of your down payment, credit cards and outstanding loans.
It may be a good idea to find out if you have a good credit rating before approaching a lender especially if you have nagging doubts. Your local credit bureau should provide a credit rating report to you at no charge. If you don't have the time to go in person you can also obtain a free copy through the mail by calling Equifax at 1-800-465-7166 or TransUnions Consumer Relations Centre at 1-800-663-9980. You must fax two pieces of government issued identification, social insurance number, date of birth, current address as well as any address you have had in the last five years, and the name and number of your current employer. Expect to wait at least ten days to receive your report by mail. Once you have your report you will know if there are any roadblocks in the way of your mortgage and you can present that report to potential lenders. Be aware, however, that lending institutions have access to information on the number of credit checks you or other lenders have requested.
If your credit rating is acceptable, the lender should be able to provide you with a loan rate, lock in the loan if you wish, and provide a closing statement which outlines the cost of your loan and how much you will need for a down-payment.
If your credit rating is less than stellar, you may use the services of a mortgage broker rather than a direct lender. A mortgage broker will search out a variety of lenders to find one who can accommodate your loan.
Once you have a pre-approval letter you have several advantages. You will know your price range and be able to concentrate on finding the right home. Then once you have found it, you will almost certainly have leverage in negotiations. A seller who receives several bids in the same price range is looking for a buyer who can close the deal. The pre-approval letter accompanying your offer is a great advantage over the competition (i.e. all the other people admiring the beautiful hardwood floors and the large backyard!) Both parties have greater peace of mind knowing that the other is committed to the deal.
Saving time is the great advantage of being pre-approved. If the seller is in a hurry to move or has already moved because of a new job in another city for example, your offer will look attractive since you will be able to close much faster. Typically, arranging the loan is the most time consuming step in the process. With the loan pre-approval already arranged, it will take only a matter of days to complete the appraisal, inspection and closing.
You may also find that sellers and agents are more interested in taking the time to show you a house. Don't be surprised if you are given the royal treatment!
The Fine Print
Remember that this letter is time-sensitive usually expiring within 60-90days (a 90-day period is most common and most beneficial to the consumer). It is important to note that the entire transaction must take place within the given time frame in order to receive the pre-approval rate. There are three steps in the process: pre-approval, application and funding. The application takes place when the prospective homeowner finds a property and applies to receive the mortgage. Funding is the actual arrangement of the mortgage and payment to the other party by your bank.
Since it can be difficult to find the home you want, make the application and arrange the funding within the pre-approval period, lenders use a few methods of calculating interest rates which actually benefit consumers:
If the 90 day period has expired, a customer is not eligible to receive the pre-approval rate, however, if the application took place within the 90 day period, he or she would receive the lower rate of either the funding date or application date.
If the closing date extends beyond 90 days from the application date, the customer would then receive the lower rate of the funding date or the 90th day prior.
It is beneficial to be able to complete the entire transaction within the pre-approval time frame when interest rates are rising. If for example, rates are 7% on the day of pre-approval, 7.2% on the application date and 7.5% on the funding date, you would receive your mortgage at 7%.
Also keep in mind that the pre-approval is not binding on the lender, is subject to the appraisal of the house you wish to purchase, and is also subject to your financial situation remaining unchanged throughout the duration of the pre-approval period.
Overall, pre-approval is a great benefit to consumers: it saves time, worry, and money.