A pre-approval is a process in which a lender commits to lending money to someone on the basis of information provided by the borrower and verified by the lender. Pre-approval is commonly used during the home buying process by buyers who want to show sellers that their offers are serious and they can afford a house. By getting pre-approved, borrowers can also shop more effectively, because they know exactly how much they can afford and they can prove this to sellers.
The concepts of pre-approval and pre-qualification are often confused. Pre-qualification is a very quick process in which a borrower provides estimates of income and the amount of money available for a down payment, and a lender uses this information to provide a rough idea of how much it might be willing to offer. In pre-approval, a specific lender reviews and verifies information, performs a credit check, and extends an offer of credit to a borrower.
Pre-approval is subject to some caveats. If a borrower's financial situation changes between the time of pre-approval and the time of a purchase, the amount a lender is willing to offer can change. Typically lenders issue pre-approvals with expirations to avoid situations in which people use an old pre-approval offer with inaccurate or dated information to make an offer on a home they cannot afford. Likewise, while the loan is for a set amount of money, a lender may decline to extend a loan on a particular home for reasons ranging from problems with the title to questions about the condition of the home.
People who are shopping for homes are often advised to get a pre-qualification letter and to use this when approaching real estate agents to discuss their options. This letter can be used to narrow down the selection to houses which the buyer can reasonably and comfortably afford. Once the buyer is getting ready to make an offer, the buyer can work with a specific lender or with a mortgage broker to get a pre-approval letter which will be packaged with the offer the buyer makes for a home.
Pre-approval is not required for the home buying process, but it can be very helpful. There may also be certain situations in which sellers demand a pre-approval letter as part of the offer process. Sellers may do this to avoid fishing, in which people make offers on homes they don't have a firm intent of buying, and to avoid wasting time; sellers do not want to negotiate with a buyer who doesn't have a realistic expectation of paying the asking price, for example.