Pre-Qualification and Pre-Approval were once separate terms used to convey an important distinction in the home buying process. This distinction served to protect the borrower (buyer) from getting into escrow on a new home only to find out the lender would not approve the loan. It also protected the realtors and the seller from wasting an inordinate amount of time and energy on a transaction that didn’t close.
During the mortgage and real estate boom of 2005-2007, the lines became blurred and the distinction less apparent and important to everyone involved. The status quo became that a simple pre-qualification letter from the buyer was enough backing for all parties to move forward into escrow on a transaction. The realtors involved may have looked at the letter and possibly even called the mortgage professional who signed off on the letter to ask a few questions, but that’s about it. Of course there are exceptions, but having personally been involved in hundreds of transactions since 2003, I can say with confidence that this is still the norm.
So much heartache has been caused and continues to this day, because of this practice. Why? Let me explain the differences of each type of letter for you to draw your own conclusions.
A pre-qualification letter is from a mortgage professional (ie. loan originator, mortgage broker, mortgage banker….all are titles that cover the person responsible for taking the initial loan application) essentially saying the buyer is qualified to buy a home. The mortgage professional will usually arrive at this conclusion by taking an application, and running a credit check. Once the applicant’s income and asset documentation is provided and reviewed to confirm the information on the application is correct, the pre-qualification letter is generated. The essence of this is the assumption that the mortgage professional knows what they are doing and has done their diligence. The pre-qualification letter is basically just their personal stamp of approval. At this point, there is not specific property but the application lists an estimated sales price and monthly payment.
By comparison, a pre-approval is when an actual underwriter on behalf of lender or bank has reviewed an applicant’s ability to qualify and issues a conditional approval. This approval lists in detail the parameters of the loan and items needed to be provided/verified in order to close.
The big difference is that the underwriter is the one whom ultimately determines if the applicant will get the loan, not the mortgage professional. Therefore, the pre-approval carries much more weight than the pre-qualification. Neither are iron clad, but underwriters are trained and paid specifically to do that one single task, where as the mortgage professional is not.
Looking back at it, I can see why this happened. Lending was loose, loans were easy to get and a new breed of real estate agents were able to take a more relaxed approach, because getting the loan wasn’t as much the issue and if a certain lender or bank couldn’t perform there were plenty of others who would. While we can certainly see why it happened, it doesn’t mean it should have, nor it is acceptable that this continues as the status quo.
I’ll expand more on the differences and the processes for each on a separate post to be written later, but for now let’s focus on a few reasons why consumers, realtors, and the entire industry should require pre-approvals and not pre-qualifications.
1. Both buyer and agent can shop for and negotiate the price of the home with more confidence.
2. The risk of having the transaction cancel due to the buyer’s inability to get financing goes down considerably.
3. The speed in which the lender/bank can process and close the loan increases considerably.
4. If done properly, getting a full pre-approval may only take a few more days as compared to a full pre qualification.
5. The removal of the loan contingency becomes a much easier and natural process.