During his 20+ years in the home loan business, Patrick Kobielsky, a mortgage advisor for Pacific Sunbelt Mortgage, has seen other lender’s deals fall apart and interest rates change at the last minute due to mistakes made during the mortgage loan pre-approval process. He recalls one deal in particular, where a buyer’s accountant filed his personal returns but made a mistake on his business returns. The IRS rejected this buyer’s tax returns, and he didn’t know about it. In the end, his loan had to be switched to a bank statement program, which increased his interest rate from 4% to 5.5%.
Scenarios like this can be avoided by getting a fully underwritten loan approval in advance. But what about pre-qualification? Isn’t that enough? To begin answering that, consider this analogy…
Your health has deteriorated, and the disease is believed to be terminal. You go to see a specialist. Without even checking your vitals, your doctor prescribes a cocktail of drugs.
“Will the medicine work, Doctor?” You ask from the hospital bed. “Will it save my life?”
Doctor Vague tilts his head to the side, shrugs, and says, “I’m not 100% sure what’s wrong with you, but this should work.”
You storm out of the hospital in frustration, wishing you had a definite answer. You know something’s not right. How could someone put your health at risk without even taking your blood or asking you questions? The possibility of death, however small, scares you. It’s your life on the line, which is no small thing. The stakes are higher than ever. And when the stakes are high, probably just doesn’t cut it.
Luxury real estate transactions are not life-or-death, but they operate on a similar level of urgency. Before accepting an offer, sellers need some reassurance that the buyer can acquire a big enough mortgage to ensure the success of the transaction. Likewise, to avoid surprises, buyers should know their options before they start shopping. That’s why the loan pre-approval process is so crucial.
The distinction between pre-qualification and pre-approval leaves some buyers confused. So, what is the difference? And which is the stronger option?
Pre-qualification is the initial step in the mortgage process. Essentially, it’s an evaluation of your creditworthiness based on information you provide to a lender regarding your credit, income, and debts. Acquiring a pre-qualification letter is a quick process that only takes lenders 20-25 minutes to complete once they gather the appropriate documentation. The pre-qualification letter contains an approximation of a loan that you will likely be eligible for. This gives you an idea of what interest rates and payments you can expect, but it’s not a guarantee.
Tim Deibert, a licensed mortgage loan originator for All Western Mortgage, says that potential buyers miss out on homes all the time because of mistakes made during the pre-qualification process. He saves one or two loans a month for buyers who thought another lender had already approved them, but who had only been pre-qualified or who missed an important step—like supplying all their financials on time.
In some instances, buyers who know they earn enough money for a home forget that sellers are going to want to see proof. Pre-qualification relies on a borrower’s word, which is not always documented, especially for those who are self-employed. They might have $2MM in the bank but no W-2 work to prove their income, which means they’ll have a hard time ensuring lenders that they can make payments due to predatory lending laws. This seems absurd, but it’s the way things are.
Additionally, Patrick Kobielsky says, “Most buyers don’t realize that every dollar for the down payment and the closing cost has to be verified from an acceptable source, and mattress money is not considered an acceptable source.” Even if you have duffel bags full of legally-acquired cash, it won’t help you acquire a mortgage. Lenders will have big doubts about where that money came from. In fact, lack of income verification is one of the most common reasons that contracts fall through.
In short, there’s a lot that can go wrong, especially if you only get a standard pre-qualification. Luckily, there is a way avoid these potential pitfalls and to ensure you’re in an excellent position to buy a home.
Underwritten pre-approval goes much deeper than simple pre-qualification. According to Tim, a typical underwritten pre-approval takes four to five man hours, a far more involved process than a 20-minute pre-qualification. During this time, an underwriter reviews all of the buyer’s financial information: credit reports, pay stubs, bank statements, salary, assets, and obligations. With this information, lenders get a far more vivid picture of the buyer’s financial situation, which allows them to strongly commit to the deal.
Underwritten pre-approval carries much more weight. Unlike the should of pre-qualification, it provides peace of mind that your financials have been reviewed and approved, so you can write your offer with confidence. This allows you to close quicker once you have a home in contract. Additionally, Kobielsky says, “an underwritten pre-approval gives the buyer and lender time to structure their deal ahead of time—in the event that something doesn’t work right now, but may work in the future.” It gives buyers the chance to resolve any money issues well in advance, such as documenting their duffel bags full of cash by depositing that money long before it’s used as a down payment.
With a fully underwritten pre-approval letter in hand, a buyer is instantly more competitive in the market and has better negotiating credibility. Knowing that a buyer’s loan pre-approval is fully underwritten also gives the seller peace of mind. When the real estate agent and seller receive the underwritten pre-approval letter, they know for a fact the deal will close (assuming there aren’t any last minute credit, job, or income changes).
This is not unlike the peace of mind you get when you ask, “Will the medicine work, Doctor?” and he says, “Yes, definitely.”