The Importance of Pre-Approval in the Home Search
One of the most often skipped steps for first-time home buyers is getting pre-approved for financing. After all, looking at and dreaming about homes is the fun part. Having all of your finances carefully scrutinized, not so much. The pre-approval process is a necessary first step for anyone in need of financing who is seriously looking for a new home.
Sets Unrealistic Expectations
Skipping to the fun stuff can create problems in the searching process and can lead to heartbreak. Often, people don’t know what they can afford and wind up wasting time looking at homes that are not within their price range.
When people look at homes above their price range it sets expectations that homes within their price range often cannot match. This tends to lead to a longer search and the discounting of properties that may otherwise have checked most of the boxes.
Not Positioned to Make an Offer
In a competitive market any offer that comes without a pre-approval letter is not taken seriously unless the buyer can cover the cost with cash or assets. If a buyer is looking at homes and finds their dream home before getting pre-approved, that buyer is not well-positioned to make a serious offer until they can present a pre-approval letter with their offer. This can lead the buyer to either miss out on the house, or scramble at the last minute to get a pre-approval letter. The last minute scramble is not advisable because it prevents the buyer from fully evaluating and comparing lenders, which is a critical part of the transaction.
Pre-Qualified vs. Pre-Approved vs. Pre-Underwritten
There are three different types of letters that you can get from a lender which reflect the level of vetting that the lender has completed. Often, the terms pre-qualification and pre-approval are used interchangeably, but they are not the same thing. In fact, letters of pre-qualification are not given much weight when presenting an offer and pre-approval letters are more widely accepted. It’s key to understand the difference between these terms and their weight in putting together your offer.
Pre-Qualification: A pre-qualification letter is generally easy to get and there is typically little to no verification of information supplied to the lender. Credit reports are not run as part of the pre-qualification process and there is typically little, if any verification done on the buyer’s finances. In many cases, the buyer describes their income, debt and assets and based upon that information, the lender makes a judgment on the amount they can lend assuming the accuracy of the information provided. Because there is no independent verification provided, a seller would not put much stock in pre-qualification as an indication of the ability to get a loan, so it carries little weight. Pre-qualification does have its advantages when comparing lenders and in getting a ballpark estimate of the price range to search for.
Pre-Approval: A pre-approval letter is widely accepted by sellers that the prospective buyer is serious and has the ability to get a loan. The process involves a credit check as well as a review of financial statements, including bank statements, tax returns and W2s among other things to best determine a buyer’s credit score, employment history, assets and liabilities and debt to income ratio. The pre-approval letter will indicate what type of loan the buyer qualifies for and the amount of the loan. The process doesn’t involve underwriting, but it does involve a good degree of scrutiny, strengthening the offer. However, a pre-approval letter does not guarantee the loan will be funded, leaving some risk to sellers if they accept an offer and the loan doesn’t fund.
Pre-Underwritten: Getting a loan pre-underwritten essentially guarantees that the buyer will be given a mortgage up to a certain amount. It goes beyond the pre-approval stage by having an underwriter review the financials, which involves a considerable amount of scrutiny and effort. A pre-underwritten loan is extremely valuable to sellers because many consider it to be the next best thing to a cash offer. There still could be some hiccoughs if the property doesn’t appraise to the sales price, particularly if the prospective buyers can’t come up with cash to make up the difference. In a competitive market, getting pre-underwritten can set an offer apart from competing offers, but it involves a considerable amount of extra work.
It is always a good idea for buyers to discuss the pre-approval process and selecting a lender with their real estate agent. All markets are different and real estate agents will know the expectations of every market.
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by Sean Engmann
Realtor® at Coldwell Banker
DRE # 02117899