Chances are good your buyers are not approved at all…they’ve only been pre-qualified

Shocking headline, isn’t it?  Hard to hear the truth sometimes, but I am going to tell you that in my experience, the bulk of Pre-Approval letters being given to Real Estate agents by Loan Originators are just plain worthless.  They are being written to get the buyers a house, but the protection/reassurance the seller is looking for that tells them the buyers really are qualified does not exist.  Welcome to Fantasy Island.

My intention in writing this is two-fold: first, to let you know about this situation, and second, to give you some suggestions for getting a comfort letter that is worth the paper it is printed on.

Frequently a Realtor will refer me one of their clients who is interested in purchasing a home.  The client may be a first time buyer or a seasoned home owner, and often they are looking for my guidance to help them determine how much house they can afford to look at.  When I have a conversation with the buyers I am attempting to determine the ability of a buyer to purchase a given amount based upon their income, monthly debt payments, and savings available for down payment and closing costs.  This can be done on the phone but frequently I sit down and meet with the buyers in person so I can explain the home buying process to them in detail and answer any specific questions they may have about mortgages and closing costs. This type of meeting is called a mortgage pre-qualification meeting, and this meeting is an essential first step on the road to homeownership for buyers.

The mortgage pre-qualification or pre-approval letter is given to offer the sellers the assurance that the buyers have been properly evaluated as credit worthy. A seller needs this reassurance when they are dealing with one of the biggest assets they own, their home, and rightly so.

When I do a mortgage pre-qualification I ask the borrowers for permission to pull their credit report, because their credit profile is a major factor in determining whether they will be able to get financing for a home.  I believe a borrower’s credit report is essentially a selfie of their financial affairs at a specific point in time, so if a borrower has an excellent credit profile, they would be an acceptable risk to lend money to for a home purchase. However, if a borrower does not pay their monthly bills on time it is not likely that they will pay their mortgage in a timely fashion either.

When a borrower is seeking a mortgage, the 3 big determinants of a borrower’s ability to repay a mortgage are income, monthly debt payments and credit history, and the ability to save money for the down payment and closing costs required for the transaction.

If borrowers have acceptable credit, show the ability to afford the financing by qualifying for the mortgage, and the ability to manage their finances and save money they would be pre-qualified for the financing.

Sounds easy, doesn’t it? Well sometimes it is, but often it is not.

That is because there are issues that arise with respect to borrower’s income and employment, or their capacity to accumulate the funds needed for a down payment and closing, or aspects of their credit that make a pre-qualification difficult.

In these situations the loan officer needs the help of an underwriter to determine if the applicants can obtain financing for a home purchase, and that is not a pre-qualification, that is a Pre-Approval.

In todays’ mortgage marketplace, borrowers are pre-qualified by lenders using electronic underwriting tools, an electronic decisioning engine. The 2 most common are Desktop Underwriter, or DU, used by Fannie Mae, and Loan Prospector, or LP, used by Freddie Mac. When a loan officer pulls a borrowers credit and enters their income and assets in DU or LP, the system evaluates the scenario and issues an Underwriting Decision for that scenario. To be able to tell a borrower they are pre-qualified for financing, the Underwriting Decision must come back as Approve/Eligible. If it does not come back this way, some aspect of the borrower’s income, assets or credit is outside of the scope where the computer can issue an approval.  

It is important to know that a DU or LP approval is not an Underwriting Approval…it is only a Pre-Qualification for a loan scenario based upon the information that was presented in the file which has not been verified. If the borrower do not make the income they claim, or if they have additional undisclosed debts, or if the assets presented are not accurate the DU/LP approval is no longer valid.  Therefore data integrity is the most important part of a mortgage pre-qualification and decision. And date integrity is the responsibility of the loan officer.
When a borrower is pre-qualified for financing, I send the Realtor a letter stating that they have been formally pre-qualified for the financing to buy a home. It is not a guarantee that the financing will go through.  The only way to get a guarantee that the financing will go through is to get a Pre-Approval.

A pre-approval is a loan decision reviewed and signed off on by an Underwriter, very much like a formal loan application except that the borrowers have not yet found a property to purchase. In a pre-approval the borrower sign some application documents and they must supply all their supporting documentation for their income and assets.

I personally do not do a pre-approval for a borrower unless there is some aspect of the file that needs to be reviewed closely in order to get a decision. For example, if a borrower has a bankruptcy in the past I would rather have an Underwriter sign off on a file where I had supplied a letter of explanation for the cause of the bankruptcy, and all the paperwork that supported the bankruptcy filing. I would do the same thing if there was an ongoing history of late payments that showed up on the credit report. If the borrowers are self-employed and I am not comfortable determining their income I would submit that for pre-approval as well.

Because a Pre-Approval is an actual loan decision made by an Underwriter who has evaluated the income and assets of the borrowers it is considered in the marketplace to have more weight behind it than a Pre-Qualification. That is because the Loan Officer is the one issuing the Pre-Qualification and they may not have all their facts straight, or they may have evaluated the income incorrectly, or the borrowers will not fit the program guidelines for the financing being sought, and once the actual loan is being processed, these problems are identified and the borrowers cannot get the financing they thought they had. And that is a HUGE problem for all the parties.

What I have been seeing is Loan Officers issuing mortgage Pre-Approval letters in hot markets in an effort to help their borrowers get the house, when in actuality, the buyers have only been Pre-Qualified.
This type of situation, which is being done supposedly for the benefit of the buyers, is actually a deceptive practice and could end up harming all the parties to the transaction. So the issue for prospective home buyers and Realtors is to make sure that you know who you are doing business with, and getting a Pre-Approval letter from, that they have a track record in the industry, and that the Pre-Approval you are being given has actually been issued by an Underwriter, not a Loan Officer.

Robert H. Ruth
Senior Mortgage Banker
Direct: 401.789.4441
Mobile: 401.743.4364
NMLS ID: 513243


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