In competitive buyer’s markets where houses for sale are few and far between and homes for sale typically receive multiple offers, buyer’s need to position their offers with as much strength as possible. This may include offering fast closing dates, making offers above the asking price, and including a pre-approval letter with their offer.
At times, buyers may not understand what they need and may approach their loan officer or mortgage company with requests for a Pre-Qualification Letter or a Loan Commitment Letter. While these may sound interchangeable, they are not. These documents are different and represent different levels of due diligence and commitment by the lender. They are also used at different stages of the home buying process.
A pre-qualification letter indicates that a loan officer or mortgage company representative has reviewed some preliminary loan application information provided by the borrower either verbally or in writing, but has not yet reviewed or confirmed financial documentation. In simple terms it means that the buyer, who is also the borrower, appears to be qualified enough to apply for a loan.
Pre-qualification letters were often considered sufficient proof that a buyer was likely to get a loan. However, prequalified buyers were often not approved for loans making sellers have to renegotiate contracts or find new buyers. Today, pre-qualification letters are often found to be insufficient and pre-approval letters are favored.
A pre-approval letter demonstrates a deeper level of due diligence by the lender. To receive a pre-approval letter, the lender has typically already reviewed credit reports, income documents, and bank statements. In some cases, the bank or mortgage company may enter the borrower’s data into an underwriting system that will specify if the borrower is qualified enough to move forward with the loan process. It will also provide a maximum amount the buyer can borrow from the lender.
When a buyer submits a pre-approval letter with an offer on a property, letter will usually list the price, loan amount, down payment amount, loan-to-value, and possibly the terms of the loan. The letter will also outline what documentation is still pending from the borrower to complete due diligence in the underwriting process.
While not a guarantee a loan will be approved or funded, a pre-approval letter gives the seller and their agent strong assurance that thy buyer has the financial means to purchase the home or property for sale. In competitive markets with multiple offers, seller can review offers with pre-approval letters and chose the buyer with the most favorable terms and likelihood to get funded.
A mortgage loan commitment letter is provided by a bank or mortgage lender after the buyer has passed through a rigorous underwriting process. This type of letter is provided later in the contract time period, approximately a week or so before closing. There are still conditions to be met such as no change in the buyer’s financial landscape and a favorable appraisal. However, commitment letters are interpreted as assurance that the buyer’s loan will be approved and funded for closing.
Knowing the difference between a Pre-Qualification Letter, a Pre-Approval Letter, and Loan Commitment Letter can be critical for buyers and sellers to make informed decisions during a real estate transaction.
Buyers can add strength to their offers in competitive markets with well written pre-approval letter from a reputable lender. Sellers need to know the difference so that in considering offers, they enter into contract with the buyer who offers the best contract terms and is most likely to be qualified for a loan.