As with much of the real estate industry, the mortgage industry uses terms that sound great, but really are not what they sound like. The loan prequalification is such a phrase.

If you have shopped for a home, you know all the interesting terms people use to describe their property. A cozy home can be translated to mean the home is essentially a closet with a bathroom. A rustic home often means the place is so decrepit, scientist study it to see if it is breaking the laws of physics by remaining upright. I am sure you have more than a few examples of your own.

In the mortgage world, loan prequalification is an activity and phrase that is interesting. The basic idea is a buyer goes to a lender prior to shopping for a home and attempts to determine what they can borrow. The lender does a cursory interview and maybe looks a paycheck stub. The lender representative then declares that buyer is prequalified for a certain amount. With letter in hand, the buyer heads out to find that unique property that is just right.

While this all may sound great, there is a serious problem. A prequalification determination by a lender is not worth the paper it is written on. Anyone can get prequalifed. The lender has really made no determination. All they have done is give you a piece of paper that they hope will get you to come back and actually apply for a loan with them. The bank hasnt actually run though any of the criteria it uses to write a loan, so there is no value to it. The dollar figure quoted in the letter might as well be for a bazillion dollars for all it is worth. The prequalification letter is not binding on the bank.

As you can imagine, this scenario represents a trap from some buyers. When given the prequalification letter, they assume they will get a loan for the amount in question. They then make a purchase based on the figure. Imagine their surprise when the bank subsequently rejects their application or approves them for a lower amount. The trap has closed on them and they will lose their earnest money deposit on the real estate transaction. This happens every day.

Loan prequalification letters are useless, but pre-approval letters are another matter. A loan pre-approval works the same way as a prequalification letter. The difference is that you actually go through the entire loan application process. The bank then makes a final determination and pre-approves you for a loan amount. The pre-approval is binding on the bank, but usually for a short period of time such as 30 days or so. If you obtain a pre-approval letter, sellers will be very receptive to your offers.

In mortgage, you should keep in mind that it is pre-approval, not qualification, that is the magic ticket.