Mortgage preapproval vs. prequalification: what a letter tells you

Two names, one question: what did the lender check?

The CFPB says prequalification and preapproval letters both state how much a lender is willing to lend you, up to a certain amount and based on certain assumptions. Some lenders issue a prequalification letter based on unverified information you report and give a preapproval only after verifying it. Other lenders use only one of the names, and the same kind of letter may go by either one. The CFPB’s advice is not to worry about which word a lender uses, because the label tells you little about that lender’s process.

So ask directly. Did the lender pull your credit? Did it review your pay stubs and bank statements, or take your word for them? The CFPB also notes that some lenders respond to these requests with a written commitment to lend up to a specified amount for a certain period, subject to limited conditions. A verified letter gives you a more reliable number to shop with.

The CFPB notes that many people wait to get a preapproval letter until they are ready to shop seriously for a home, but getting preapproved earlier can reveal credit problems in time to correct them. If your letter comes months before you apply, its credit check may fall outside the 45-day window for later lender comparisons (see below), adding one inquiry, which the CFPB says has a small effect.

Sources: CFPB: Prequalification and preapproval letters · CFPB: When a mortgage lender checks your credit

What a letter is not

The CFPB is clear that neither letter is a guaranteed loan offer. The assumptions behind a letter may not survive verification and an appraisal. Nor is a letter a Loan Estimate. Under Regulation Z, if a lender gives you a written estimate of terms or costs specific to you, such as an estimated monthly payment, before the Loan Estimate, it must warn at the top of the first page that your actual rate, payment, and costs could be higher and tell you to get an official Loan Estimate before choosing a loan.

The CFPB says a letter still helps you make an offer because it gives the seller confidence that you can get financing, and suggests asking a local real estate agent or a housing counselor whether your letter will serve that purpose. If a lender evaluates your credit and tells you that you do not qualify for a letter, the CFPB notes it must give you an adverse action notice, a notice that the lender turned you down, even if you never submitted a formal loan application.

Sources: CFPB: Prequalification and preapproval letters · CFPB: Regulation Z § 1026.19(e), Loan Estimate timing and fees

When you have applied: the six pieces of information

For most mortgages, Regulation Z defines an application as six pieces of information: your name, your income, your Social Security number so the lender can obtain a credit report, the property address, an estimate of the property’s value, and the loan amount you want. The official interpretation says a lender may collect more, but once it has those six items, it has an application. Until you name a property, a lender does not have all six, so a letter typically arrives without a Loan Estimate.

An application starts a clock. Under Regulation Z, the lender must deliver or mail a Loan Estimate no later than the third business day after receiving the application. The CFPB notes that you do not need a signed purchase contract or income documents to get one, and that a Loan Estimate is neither an approval nor a denial. Until you receive it and say you intend to proceed, the lender may charge only a reasonable credit report fee, not application, appraisal, or underwriting fees.

Sources: CFPB: Regulation Z § 1026.2(a)(3), definition of application · CFPB: Information needed for a Loan Estimate · CFPB: Regulation Z § 1026.19(e), Loan Estimate timing and fees · CFPB: What is a Loan Estimate? · CFPB: Documents and lender requests · CFPB: What is a Closing Disclosure? · Fannie Mae Selling Guide: Allowable age of credit documents · CFPB: When the appraisal is less than the sale price

Shopping several lenders without piling up inquiries

The CFPB says a credit check from a lender is reported as an inquiry, which typically has a small negative effect on your credit scores. But according to the CFPB, multiple credit checks from mortgage lenders within a 45-day window are recorded on your credit report as a single inquiry, as long as the last check falls within 45 days of the first.

Plan the timing so lenders’ credit checks fall close together, inside one window. The CFPB adds that shopping is usually still worth it even if a lender checks your credit after the window, because one more inquiry has a small effect and shopping around can save a lot of money. Checking your own credit reports and scores does not affect your scores.

Sources: CFPB: When a mortgage lender checks your credit

The documents lenders ask for

The CFPB’s application packet checklist lists what to gather: pay stubs for the last 30 days, W-2 forms and signed federal tax returns for the last two years, records of any other income, your two most recent bank statements, and statements showing the source of your down payment with at least two months of ownership history. Add proof of identity and your Social Security number. If part of the down payment is a gift, the CFPB suggests a signed statement from the giver saying so.

Once you choose a lender, expect requests to verify what you reported. The CFPB notes that lenders are generally required to verify the source of your income and down payment funds, so be ready to explain large deposits, and that some loans do not allow gift funds for the down payment. Self-employed borrowers may need more documentation. Send complete copies, keep the originals, and answer requests quickly.

Sources: CFPB: Create a loan application packet · CFPB: Documents and lender requests

The letter amount is a ceiling, not a budget

A letter’s amount reflects the lender’s limits, not your household’s. Lenders compare all your monthly debt payments, including the new housing payment, with your gross monthly income, and the CFPB notes that the maximum debt-to-income ratio varies by loan product and lender. Your budget runs on take-home pay after taxes, savings, and everyday spending, so a mortgage budget built from your own numbers can land lower.

Take a hypothetical household earning $8,500 a month before taxes, with $625 of other debt payments and $6,400 of take-home pay. At an illustrative 45% ceiling, total debt payments could reach $3,825.00, leaving $3,200.00 for housing. With $35,000 down on a 30-year fixed loan at a hypothetical 6.875% and the table’s tax and insurance assumptions, that supports a price of about $409,407. After $3,430 of spending and savings and the $625 of debts, take-home pay leaves $2,345.00 for housing, which supports about $302,344: a home $107,063 less expensive and a payment $855.00 a month lower. The $3,200.00 payment would take 50.0% of take-home pay.

Sources: CFPB: Debt-to-income ratio

What can undo an approval before closing

A letter, and even a Loan Estimate, rests on the facts at the time. The CFPB names four changes that can alter your terms, even a locked rate: a different loan type or down payment, an appraisal that differs from what was expected, a new loan or missed payment that changes your credit, and income the lender cannot document. It also advises against applying for other credit right before or during the mortgage process.

Your job gets a late check too. For loans it buys, Fannie Mae’s Selling Guide generally has lenders confirm employment within 10 business days before the note date (120 calendar days for self-employment income), and a change in employment must be fully reevaluated. The note date is the date on the loan note you sign at closing. If the appraisal comes in below the price, the CFPB calls buying for more than the appraised value very risky and suggests asking the seller to reduce the price; if the seller will not, you may want to cancel, and the CFPB suggests consulting an attorney, since your contract may carry cancellation costs.

Rates move as well. The CFPB notes that an unlocked rate can change at any time. In the example, if the rate on the $374,407 loan rose from 6.875% to 7.375% before you locked, principal and interest would rise by $126.35 a month and total debt payments would reach 46.5% of gross income, above the 45% ceiling. At the higher rate, the same ceiling supports about $394,227, or $15,180 less.

Sources: CFPB: Which Loan Estimate costs can change · CFPB: Mortgage rate locks · CFPB: When a mortgage lender checks your credit · Fannie Mae Selling Guide: Verbal verification of employment · CFPB: When the appraisal is less than the sale price

How long a letter lasts

The CFPB’s guidance does not set a standard life for a prequalification or preapproval letter; it notes only that a written commitment may be valid for a certain period of time. Ask how long your letter is valid and what the lender will need if your search runs longer.

The paperwork behind a letter ages. For loans Fannie Mae buys, its Selling Guide says credit documents, including credit reports and income, employment, and asset records, must be no more than four months old on the note date, and older ones must be updated. A rate lock is a separate clock: the CFPB says locks are typically available for 30, 45, or 60 days and may be expensive to extend.

Sources: CFPB: Prequalification and preapproval letters · Fannie Mae Selling Guide: Allowable age of credit documents · CFPB: Mortgage rate locks

Your next-step checklist

• Ask each lender what it verified and whether it pulled your credit.
• Ask how long the letter is valid and what would require an update.
• Gather pay stubs, W-2s, tax returns, bank statements, and down payment records.
• Keep lenders’ credit checks close together, well inside the CFPB’s 45-day window.
• Set your housing payment from take-home pay before you set a price.
• Hold off on new credit until after closing, and report any job change early.