What buyers and sellers need to know about the loan pre-approval letter.
What's a loan pre-approval letter? It's how a lender tells a buyer, "I promise I'll help you buy a house".
That's the premise. The sordid reality is that a pre-approval letter can mean what is says or say nothing of meaning. In a 2005 survey by Campbell Communications, unreliable pre-approval letters were a concern for 51 per cent of agents polled. That's why buyers and sellers need to know the whys and wherefores of pre-approval letters.
Buyers, the first benefit of having a pre-approval letter is that a knowledgeable, experienced real estate agent will work with you. That's a good thing.
Let me explain why. Agents start their careers working with buyers who say, "I'll get pre-approved when I find a house I like". Often these buyers do find a house they like, after the agent has spent much time with them, then find that they can't even afford a house they don't like. Clued-in agents—the kind you want to work with—quickly stop seeing this as "good experience" and start using the pre-approval letter (or lack thereof) to screen their clients.
Sellers, not all the pre-approval letters you'll see are created equal. They'll fall somewhere along a continuum.
At one end is what might be called the Burger King® pre-approval, as in "Have it your way®". Instead of "this is how much loan the buyer can afford", it's "this is how much loan the buyer would like to afford". Sometimes the difference is big enough to drive an agent's black Mercedes through.
Lending is a competitive business. Some loan agents are too anxious to please, or too busy or careless to ask you every question and fill in every blank. Or they figure that once you're sitting at the closing table with pen in hand you'll take whatever loan they hand you—and they're right. "How does this work in real time?", you ask. Once you get into contract, the loan agent stops returning your calls and starts frantically working the phones until, and if, things work out. Meanwhile, everyone else—you, your agent, the sellers, their agent, the title company—is pulling their hair out. Think buying a home is stressful? Try doing it with a flakey loan agent. What's even more unfortunate is that after a while a buyer's agent learns to see this train wreck coming, yet the buyer has been hooked so successfully by the loan agent that he refuses to listen.
That's one nightmare scenario. Then there's the old-fashioned pre-qualification letter face-lifted to look like an up-to-date pre-approval. Buyer has talked to loan rep for five minutes, and maybe authorized her to run a credit report. Loan rep cranks out a canned letter carefully worded to dazzle seller without actually committing anyone to doing anything silly like fund the buyer's loan. Call this the Jurassic Park pre-approval, because it's mostly special effects. No one has bothered to do the grunt work of verifying buyer's employment, income, assets and debts.
Also be cautious about a pre-approval letter written by someone who's both the buyer's agent and the buyer's mortgage broker. Realize that the buyer's agent is first and foremost the buyer's advocate. No agent presenting an offer is going to say, "Hey, I gotta be honest. There's no way my buyer can afford your house. We're hoping you'll knock a few bucks off the price when you find that out because by then you'll be in escrow and won't want to put your home back on the market". The pre-approval letter is how a neutral third-party tells you that won't happen. The problem in this case is that the "neutral third-party" guaranteeing the buyer's qualifications is also the buyer's agent and advocate. Hmm...
So what kind of pre-approval letter can both buyer and seller depend on? The take-it-to-the-bank letter. The lender promises to lend if it gets just a little more information: 1) an appraisal confirming that the property is worth what the buyer is paying; 2) a preliminary title report verifying that seller can deliver clear title to buyer; and 3) a purchase contract with no big credits from seller to buyer suggesting that neither party thinks the property is really worth the purchase price.
That's it. Buyer or seller, don't settle for anything less.