A prequalification is usually issued by a loan officer, who, after a brief conversation with you, determines the type of mortgage for which you can be approved. However, loan officers do not issue final approval for mortgages, so a prequalification is not a commitment to lend. Furthermore, a prequalification is merely a verbal confirmation that the borrower would be a candidate for getting a mortgage; based the borrower's answers to very basic questions asked by the loan officer. These simplistic questions range from, "Do you have a source of income?"... to, "What's your monthly debt?"... to, "Do you have any credit issues?"... and so on. The answers to these questions are not verified as being true or accurate at this point.
Preapproval is a step above prequalification. Pre-approval involves verifying your credit, down payment, employment history, etc. Your mortgage application can sometimes be submitted to an underwriter at this point, and a preliminary decision is made regarding your mortgage application. If your mortgage is preapproved, you are then issued a preapproval letter. Getting your mortgage preapproved allows you to close more quickly when you do find a house. A preapproval may also help you negotiate a better price with the seller, since being preapproved is very close to having funds in the bank to pay for your purchase.
There's also no cost... it's completely free, and there's absolutely no obligation.