“I had a couple come in with a negative amortization mortgage on a house that costs way too much relative to their income. They’re consuming real estate, not investing in it.”
Chris Cooper
Like most investors, you will probably be paying for your property using financing of some sort. Before determining your price range and searching for properties, you need to know if you will be able to get the loan you desire for the amount you require.
If you are buying a property using financing, the first thing you should do is get Pre-Qualified or Pre-Approved.
What is “pre-qualification”? What does it mean to be pre-qualified?
Pre-Qualification is when a lender evaluates the credit history of a potential borrower to determine an estimated range that the person can afford to borrow. Most lending institutions or mortgage brokers offer free Pre-Qualification either in person or over the phone. You will give the lender information about your down payment, assets, debts and income and the lender will then determine an estimated loan amount you could potentially qualify for. The lender will not verify your income and they will not check your credit. A Pre-Qualification is NOT A COMMITMENT to give you a loan and is the bare minimum of what you should do prior to searching for real estate.
What is “pre-approval”? What does it mean to be pre-approved?
A Pre-Approval is a tentative commitment to give you a loan in a certain amount. For a Pre-Approval you will give the lender the same types of information as you would for a Pre-Qualification, only this time they will verify all of the information you provide them. The lender will contact your employer to verify your income and check your credit to see about your debts and history. A Pre-Approval is much more desirable to potential sellers as they can rest assured that you can financially qualify to purchase the property.
The Pre-Approval will be conditional. This means that they approve you based on certain criteria. The most typical are:
- An appraisal performed on the property that is satisfactory to the lender
- The lender reviews and is satisfied with the purchase contract
- A valid title review is performed and title insurance placed in effect
- The final approval be given by the lender’s underwriting department
Which is better — a pre-approval or a pre-qualification letter?
If serious about finding a property, always go the Pre-Approval route. Many people think financing does not affect the offer and that the only thing to consider is price. This is far from the truth. Real estate financing affects every offer. It’s better for both you and the seller to be prepared with financing before making offers.
What if I’m not pre-approved?
If you make an offer on a property that is contingent upon financing, but you do not have a loan Pre-Approval or even Pre-Qualification, the seller has no cause to actually believe that you can close. Unless you can prove substantial proof of funds (i.e. having more than 20%, probably closer to 50%), the seller basically has to take your word that you can qualify. They will not know if you have a bankruptcy or a foreclosure on your record which may preclude you from getting a loan. The seller risks turning down a more qualified offer or losing time (and therefore money) opening an escrow with a buyer who cannot close.