The housing market remains extremely competitive for buyers in large metropolitan areas, where house hunters typically outnumber sellers and often come to the table with all-cash offers.
As a result, doing a little mortgage homework early in the process can go a long way when trying to put yourself in the best position to score your dream home.
Pre-Qualification vs. Pre-Approval
The main types of mortgage "homework" are a pre-qualification or a pre-approval.
Pre-Qualification: A mortgage pre-qualification is the quickest and easiest approval to get and could be done in a 15 minute phone call or brief online session. To get a pre-qualification, a potential borrower simply calls a mortgage banker or completes an online form and shares income and asset information. Generally, no backup documentation is required, and no credit check is performed. In return, the borrower receives a letter with an estimate of a loan amount that the bank may be willing to loan to him. This gives the apartment hunter a general sense of the ballpark of places they could afford.
Pre-Approval: On the other hand, in order to get a pre-approval, a borrower would typically need to complete a loan application, get his credit checked and pass along financial documentation that can be used to verify information on their loan application. Once pre-approved, the borrower would receive a letter from the bank stating the loan amount they've been pre-approved for and any expiration date associated with the pre-approval.
If you're just flirting with the idea of buying a home, a pre-qualification is a good way to get a sense of what you may be able to afford, without having to do much work at all. But if you're seriously considering purchasing a home, then a mortgage pre-approval can serve you better in the long-term.
Reasons to Get a Pre-Approved Loan
Focus Your Search: By getting a pre-approval, you'll have a better idea of what apartments are in the realm of possibility financially. Sometimes this helps borrowers realize that they can afford much more house than they initially thought, while other times, it may force them to narrow their price range.
Become a More Qualified Buyer: Because a pre-approval involves a banker actually verifying financial information provided, as well as a credit check, it carries considerably more weight than a pre-qualification - making your offer much more competitive than a pre-qualification would if you end up in a bidding war.
"A pre-approval sets the tone for knowing your possibilities," says Dovanna Pagowski, a licensed real estate associate broker with Rutenberg. "In this continued climate of low inventory, a choice purchase on the market will not last long and a savvy buyer needs to have all his ducks in a row - the pre-approval being the cornerstone."
Gain Confidence in Waiving Your Mortgage Contingency: As Douglas Elliman found in its Q3 2015 market report, there are a lot of people carrying around wads of cash and bidding on places with no mortgage. In order to make your bid with a mortgage more attractive, sellers may want you to waive your mortgage contingency in the contract of sale.
The risk of waiving the mortgage contingency is, if you aren't able to get a mortgage, you can't necessarily just walk away from the transaction. If you can't complete the purchase, then you lose your deposit, which in New York City, typically amounts to 10% of the purchase price.
However, if you've gotten a mortgage pre-approval, you may feel more comfortable waiving the mortgage contingency, because you've had the bank review three of the four core factors they consider when approving a mortgage: income, credit and assets. The fourth factor being collateral - the actual value of the house or apartment.
"Simply put, getting pre-approved for a mortgage was the only way we were able to compete with all-cash buyers and ultimately win in a competitive multiple bid market like the Bay Area," said Jerry Miller, a 33-year-old in San Francisco. "We felt comfortable waiving our mortgage contingency, if we needed to, because we had done a lot of the legwork and been vetted with the bank before our search began."
Overall, doing more work upfront with your mortgage can help pay dividends with your search. Aside from running a more efficient process because you have a good idea of what you can and cannot afford, when it comes time to actually submit offers, you'll have a leg up from other buyers that just have a pre-qualification. Lastly, a mortgage pre-approval may give you the confidence to potentially waive your mortgage contingency so you can make your offer even more attractive.