Many people, but not everyone, are aware of this but when submitting an offer to buy a home the buyer really should provide a pre-approval letter from a lender that basically says they look good for getting a mortgage for the purchase price less the down payment - assuming the buyer is going to be getting a mortgage. The seller should not accept an offer without such a letter and it's also really in the buyer's best interest to get such a letter so that they don't end up wasting weeks of time, application fees, inspection fees, and other costs on a transaction that will never close because they won't qualify for a mortgage. In fact, the buyer should really get a mortgage pre-approval before even looking to buy a home.
Ideally a mortgage pre-approval involves some degree of analysis of the financial condition of the home buyer by an experienced lender - e.g. income, debt, credit score, assets, etc... - and once pre-approved the buyer is supposed to have a high probability of actually getting a mortgage. A pre-approval is also supposed to be a bit more thorough than a pre-qualification but that distinction seems to have become meaningless in the last few years with the terms being used interchangeably and some very reputable lenders only issuing pre-qualifications.
At the end of the day what really matters isn't so much what the letter is called but what process the lender went through before issuing their letter and therein lies the problem. Some lenders might just run a credit check in between their gas station customers (that is not a totally made up scenario) while others might go the extra mile and require copies of tax returns and bank account statements. On the other hand, I've seen some Web sites that will spit out a pre-approval letter based upon very little information about you.
Therefore, it indeed helps when we see a pre-approval from a reputable lender with which we've had good experiences. I'm willing to accept their pre-approvals without question. However, sometimes we get pre-approvals from lenders we've never heard of so we need to be on the lookout for...
The Bogus Pre-Approval
Here are some flaming clues that you have a bogus (or at least worthless) pre-approval:
- Never heard of the lender and they have no Web site
- Typos in the letterhead (financial spelled fiancial)
- It's clear the lending "officer" is a one man show who simply brokers the mortgage through whatever lender will take the deal
- Email address of the lending "officer" ends in @att.net
- The lender's phone number is associated with the buyer
- The lender never answers the phone and there is no voicemail
- Letter repeatedly refers to the borrower as "he/she/their" - no, I'm not using the / to signify a choice made in the letter. All 3 choices are used every time.
- Really bad grammar in the letter - e.g. missing articles, awkward wording, repeating the same phrase multiple times in one sentence
I might accept a pre-approval letter that has one of these flags but when I see all of them in a single letter I know something is up. Also, if the buyer is responding to my Craig's List ad for the property, wants to put in an offer for the property sight unseen, and only communicates with me via email then my antennae go up.
When we get a suspect pre-approval like this we request that the buyer be pre-approved by one of our trusted lenders. They don't necessarily have to use our lender to ultimately get the loan but we want to make sure they have a reasonable chance of getting a mortgage.
But You Need To Be Careful Even With Trusted Lenders
So, let's say you have a pre-approval from an experienced loan officer working for a reputable lender. You're still not out of the woods. For instance, the pre-approval might be contingent upon some implicit or explicit assumptions that can easily be missed.
I believe that the pre-approval process usually goes through some kind of automated underwriting system (AUS). The problem is that these systems might not be aware of the special circumstances of the buyer that will ultimately come out when it goes through a full, manual underwriting process. For example, the AUS might say that the borrower can financially handle a purchase with 5% down but that doesn't mean that the buyer will actually qualify for a program that allows him to put 5% down. The buyer may be hoping to access some obscure mortgage program, the requirements of which neither the AUS or the loan officer are aware.
The pre-approval can also be contingent upon other factors, the most common of which is a friend or relative co-signing the mortgage. Ideally the letter would spell out these contingencies but it might not or the seller and their agent might miss the reference. Then the deal falls apart because the contingency is not met.
Another common contingency that can easily be hidden by the buyer is a down payment that is invested in stock. How is that a contingency? Well, if that comprises 100% of their down payment then the delivery of their down payment is dependent upon the price of that stock being sufficient to generate the necessary cash. That is never a 100% certainty until the stock is sold. Suppose the buyer waits until the last minute and the stock price drops 20% in the meantime?
Russ Martin of Perl Mortgage weighed in on this topic as well, explaining how the practical considerations of the mortgage business really make it impossible for a pre-approval letter to be highly reliable:
The main reason pre-approvals are not thorough is that lenders don’t really want to waste time doing real pre-approvals (actually underwriting the loan pending property and title) because there is an extremely high fall out rate. They rather spend time and resources on committed borrowers. Put another way, why would I as a lender want to commit all the resources necessary to truly approve a loan only to then lose that deal ...to...the guy down the street...? Every loan officer has a story of how we’ve spent months working with a borrower, even counseling them on how to fix credit, and then even talking to the listing agent to get them to accept the borrower’s offer only to then have [that] borrower dump you...
So lenders have to try to balance the needs of the business partners, clients, etc with the reality of the business environment. Good loan officers will want to see all income and asset docs and may run AUS/review guidelines, but the loan isn’t approved until it is sent to underwriting and 99% of the time that isn’t going to happen until the property is actually under contract AND the loan officer knows the borrower is committed. This is why [it] is imperative that borrowers seek out good loan officers because the pre-approval is only as good as the loan officer providing it.
The bottom line is that whether you are the buyer or the seller or one of their real estate agents don't assume that just because you are holding a pre-approval in your hand that the mortgage is in the bag. Read it carefully, ask lots of questions, and it really pays if you know the loan officer that generated that piece of paper.
#HomeBuying #HomeSelling #Mortgages
Gary Lucido is the President of Lucid Realty, the Chicago area's full service discount real estate brokerage. If you want to keep up to date on the Chicago real estate market, get an insider's view of the seamy underbelly of the real estate industry, or you just think he's the next Kurt Vonnegut you can Subscribe to Getting Real by Email using the form below. Please be sure to verify your email address when you receive the verification notice.