What is the difference between mortgage prequalification vs. preapproval?
What is the difference between mortgage prequalification vs. preapproval and why should you care?
What is the difference between mortgage prequalification vs. preapproval? We’ve all heard the terms prequalification and preapproval as they relate to mortgage financing, and we are going to explore what they are and how they differ.
Obtaining mortgage financing to fund your real estate investments is becoming more complicated every day. This is particularly true in Canada where there are have been numerous changes to government regulations and restrictions – such as the recent move to require a minimum 10% down payment for any Canadian Housing & Mortgage Corporation insured mortgage on the purchase of a property of $500,000 or more; not to mention regular changes in Canadian bank policies and conditions. This mean it’s vital to consider your lending options and have your financing in order before you start looking at investment properties.
Being a prepared investor will enable you to:
- Know what you can actually afford
- Move quickly on a good deal
- Present yourself as a serious buyer
- Reduce the stress of arranging financing at the last minute
- Attract a good, knowledge realtor.
So what are the steps to getting your mortgage financing in order? As I stated earlier, most of us have heard of mortgage prequalification and mortgage preapproval. They may sound like the same thing, but there are definite distinctions and it’s important not to confuse them.
Neither a mortgage prequalification nor a mortgage preapproval obligates a lender to provide you with a mortgage. The actual mortgage financing and commitment process can only proceed once you’ve identified a specific property. Similarly, getting a mortgage prequalification or a mortgage preapproval from a particular lender doesn’t obligate you to use that lender for your mortgage, and may even offer you the opportunity to “shop” amongst lenders if you’re in a strong financial position.
Mortgage prequalification (MPQ) should be considered as a first step to obtaining a mortgage. It is a quick estimate of your current potential borrowing power based on a few details provided by you to a lender. Think of MPQ as a thumbnail sketch that requires no documentation from you – it simply gives you a sense of things and is often done via an online Affordability Calculator (for the Canadian market; for the American market), or over the telephone with a lender.
In order to calculate a MPQ, you’ll be asked to provide some basic information:
- Your gross income
- Your assets
- Your current debts: loans, credit cards, mortgage(s)
- The amount you plan for a down payment
- Your employment history (in some cases)
After using this basic information, some banks and financial institutions will give you a MPQ letter that states the potential amount of money they might lend you, but most prefer to take it to the next step and calculate a mortgage preapproval (MPA) before providing a confirming letter.
Mortgage preapproval is a more comprehensive step than a MPQ – typically it involves an actual meeting with the lender, providing them with more detailed information and documentation, and the lender’s investigation to substantiate your information. At the end of this process, if you meet the lender’s parameters, they will provide you with a MPA letter stating the amount of money they are prepared to finance for your particular real estate acquisition – once again this letter doesn’t obligate the lender to provide you with a mortgage. The lender will also provide a timeline for the preapproval, typically 60 to 90 days, after which a new preapproval needs to be done.
Essentially, the MPA letter is a written conditional commitment by the lender confirming a buyer’s credit worthiness based on the buyer’s substantiated current financial situation and the lender’s current policies and rates. To obtain a MPA you’ll be asked to complete a detailed financial application and provide the lender with supporting documentation including:
- Bank statements
- Pay stubs
- All credit cards – qualified amount plus actual current debt
- Details of all existing loans, lines of credit, and other investment property info
- Recent tax returns
- Proof of assets – home, car, etc.
The lenders would be looking for your total debt servicing ratio (TDS), which is the percentage of all your financial servicing obligations as compared to your gross annual income. Most lenders will accept no ratio higher than 40%. The may also review your gross debt service ratio (GDS), which should be 32% or less.
As part of the preapproval process the lender will pull your credit bureau and confirm your credit rating.
A credit bureau report includes verifying all your current financial commitments, as well as your history with respect to the repayment of credit. A FICO score is part of a credit bureau report and is a number describing your credit rating, which can be vital to the amount of mortgage financing you are able to obtain. You can obtain your own credit bureau report via Equifax or TransUnion Canada, but your lender will obtain their own report.
It always serves you well to speak to a mortgage broker first, as the mortgage broker can coordinate this process for you as well, and you know that the mortgage broker is working on your behalf and will present your case to the lender. They may also reduce the number of checks on your credit bureau. By working with a mortgage broker from the start you have someone who is up on all the lender changes as they happen and by doing this you reduce the risk of any unwanted lending surprises.
Why obtain a MPQ or a MPA if you still have negotiate an actual mortgage?
As a real estate investor, you want to show that you are committed to making a purchase and can act on your interest. Nowadays, most realtors require their clients to obtain a MPQ or MPA before they’ll take you on as a client. For both the realtor and potential sellers, a MPQ or MPA indicates that you are serious buyer and have the potential capacity to make a purchase. This may be a useful bargaining tool with a potential seller and may provide an advantage in a competitive real estate market. It can also save you time when obtaining your actual mortgage, as your lender already has some (MPQ) or most (MPA) or your financial information on record.
In addition, going through the MPQ or MPA process gives you a better sense of your financial position and how you’re perceived. In the case of a MPA, any issues with respect to your credit bureau report will also be identified and this should give you time to fix any errors or address issues in order to improve your report in advance.
There are other advantages to obtaining a MPA versus a MPQ. A MPA provides a more realistic sense of what you can actually afford, as it’s based on your verified financial documentation. This should reduce stress, as you have a better sense of the range of properties you can afford. It also provides a higher potential for a deal to be accepted, as a MPA is a verified preapproval rather than a calculated prequalification like a MPQ. Ultimately, a MPA is step closer to an actual mortgage commitment, as the typical path for a lender considering providing a mortgage is to gather:
- the type of information required for a MPQ calculation,
- obtain a more detailed financial picture of the borrower and verify the information (a MPA), and
- finally, combine that information with the details of the actual property being considered for purchase to determine with to grant the mortgage.
Maintain your financial profile
There’s a last consideration once you have a MPA – don’t do anything to change your financial profile as verified by the MPA:
- Don’t change your employment
- Don’t increase your debt (if possible continue to reduce it)
- Don’t stop paying your bills ( this will change your credit rating/FICO score)
- Don’t empty your savings accounts.
It’s very important to maintain the status quo that was verified during the MPA process so as to not affect your ability to obtain a mortgage when you’re ready to purchase your investment property.
Going through the steps of obtaining a MPQ or, even better a MPA, will put you in a great position as a buyer and a real estate investor. It will enable you to work with a good realtor and make you attractive to sellers as a potential buyer. Lastly, it lets you establish a relationship with your lender and starts you along the path to obtain a mortgage when you’ve identified your desired investment property.
The bottom line is, as an investor, good deals go fast and the most prepared will usually fare better than those who are unprepared. It serves you best to treat your real estate investing as a business –you will be taken more seriously and you may even get a better deal and be able to negotiate terms and conditions of the sale.
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