Mortgage Pre-approval Letters Change with the Times

If you're soon to go house hunting, you surely want to know what's affordable before meeting home sellers and their agents. And as much as they would appreciate your interest in their property, they would be much happier if a purchase offer included some evidence of an ability to afford the home.

As a borrower, you want to consider pre-approval letters or something similar because it gives you several advantages in the marketplace:

First, it makes your offer for a property stronger because you have evidence of financial capability. If there are several offers for a property, this could be a tie-breaker.

Second, getting a mortgage pre-approval requires that you apply for your mortgage, allow a lender to pull your credit report and submit your income and asset documentation. If any problems crop up, wouldn't you rather take care of them without the pressure of a closing deadline and a moving van in your driveway?

Third, by getting pre-approved for your home loan, you know EXACTLY what you can afford to spend on your new home. You won't waste everyone's time making offers on houses you can't get financed. Note: you don't have to reveal your entire financial position to the owner or the owner's broker. For instance, if you're looking at a $200,000 home, there's no reason for the seller to know you can pay more. Flashing a letter which shows you can afford a $250,000 mortgage might hurt your bargaining position by encouraging the owners to ask for a higher bid, something they know you can afford. Have your lender give you several letters up front with different amounts, or simply request a custom letter when you make your offer.

Pre-approval Letters and Other Options

This brings us to the happy topic of mortgage pre-qualifications, pre-approvals, pre-underwriting and conditional credit approvals. These are letters from lenders which show that the borrower has some ability to afford a given level of mortgage financing.

First we have pre-qualifications and pre-approvals. The difference between them is difficult to explain for the very simple reason that neither term has a universally-accepted definition. What's a "pre-qualification" to Lender Smith may well be a "pre-approval" for Lender Jones. The expressions are often used interchangeably, so it's hard to know what a given lender actually means without asking for specifics.

Prequalification, Usually

In basic terms a "pre-qualification" letter might be described as a general and informal conversation with a lender to establish some sort of financial benchmark. You earn so much, your current mortgage is a given size, you have a few recurring monthly bills for credit cards, student loans and auto payments and so you might reasonably be able to borrow "x" amount. Many lenders do not pull your credit to issue a pre-qualification, nor do they verify your income and assets. The wording in this case is likely to be something like, "Based on information provided to us by the buyer, we have prequalified him / her for a mortgage up to $ 300,000."

Pre-approval, Usually

With a "pre-approval," you'll typically go through the full mortgage application process, completing an application and documenting your income, assets and other pertinent information.  It may also be called a "pre-underwritten" application.

The application and documents are usually evaluated by an underwriter. Pre-approval is also referred to as "credit approval" by many lenders, because to them it means that you, the borrower, are approved and can close on your loan as long as the property meets the lender's guidelines. A pre-approved borrower can close much more quickly than one who is starting from scratch.

Even a credit approval, however, is not a financing commitment on the part of the lender, because there is no property address associated with the approval, and no appraisal. Generally speaking, real estate brokers and sellers are happier to see a potential buyer with a "pre-approval" letter because that suggests a stronger and more realistic bid.

Conditional Credit Approval Letters

A more accurate approach is the "conditional credit approval" letter. In this situation, the lender likely pulls a credit report, gets credit scores, reviews recent tax returns, and asks about income. This sounds pretty much like a "pre-approval" letter but the definition of what's going on is very much better because the lender is plainly saying that no loan is being offered, just that a first step toward a loan has been taken.

As one conditional credit letter says, it's a "preliminary determination of your ability to meet the financial obligations of the loan for which you are applying. Of course, this conditional approval des not constitute an offer or commitment" to provide financing. All in all, a fair description of what's going on.

This is an important because pre-qualification letters, pre-approvals and letters of conditional credit are not loan commitments. They cannot be loan commitments because the lender has neither verified all necessary information nor received any appraisal information regarding the house -- and the house is security for the loan.

Finding Credit Dings

Because the lender has gathered a lot of data with a pre-underwriting, it becomes possible to resolve a very important problem: If credit dings are found borrowers can address out-of-date and factually incorrect items before the loan package is completed. Once inaccurate and old material is removed from credit reports, it's likely that credit scores will rise. In some cases this can mean the availability of bigger loans and lower rates.

The way to get a pre-underwriting is to start as much in advance of the house-hunting process as possible. Speak with lenders and ask them about pre-approval letters and related documentation -- and make sure to ask what information they'll need. The more they require upfront, the smoother the entire process is likely to be.

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