Though you might know how much money you want to spend on your house payment each month, that can be hard to translate into a dollar amount that you can afford to borrow. In addition, what you think you can afford might be different than what a lender is willing to let you borrow. Having a pre-qualification letter can help you figure out how much house you can afford to buy.
Pre-Qualified Letter Basics
A mortgage pre-qualification letter is a note from a bank that states the amount of a mortgage a lender would be willing to give you based on the information that you provide. Typically, lenders will ask a few questions about your income and financial circumstances, such as other debt, and then estimate the size of a mortgage you would qualify to take out. You can then use this letter when you are shopping for a home.
Getting a pre-qualified letter for your mortgage shows that you're serious about buying a home, which can make both the seller and your real estate agent more willing to work with you. For example, if a seller has multiple offers that are similar in value, but you have a pre-qualified letter and none of the other potential buyers have started looking at how they would pay, the seller would be more confident about your offer. In addition, you have a better idea of what you can afford to borrow.
A pre-qualified letter does not guarantee that you will be approved for a certain mortgage amount because it doesn't require the same type of background check as an actual mortgage application. For example, even though you would never exaggerate your income, the bank calculates what you can afford just based on your word. For example, if you claim to have an annual income of $75,000, the bank might give you a pre-approval letter for a mortgage of $325,000. However, if when you go to actually apply it turns out your income is only $50,000, your maximum mortgage amount might drop to $225,000.
Pre-Approval Letter Alternative
If you are very serious about buying a home, taking the extra time to get a pre-approval letter rather than a pre-qualified letter may be beneficial. A pre-approval letter carries more weight because you have to provide documentation to back up the information you provide, such as tax returns or pay stubs. However, even though it carries more weight, pre-approval letters don't guarantee you a mortgage. For example, you lose your job or the house appraisal comes back lower than you anticipated, the lender typically reserves the right to revoke the pre-approval.
Mark Kennan is a writer based in the Kansas City area, specializing in personal finance and business topics. He has been writing since 2009 and has been published by "Quicken," "TurboTax," and "The Motley Fool."