“Are you pre-approved?” is often one of the first questions a real estate agent will ask when engaging with a new client.
With this question, the real estate agent is trying to determine the types of properties that the client can afford and the likelihood, should this client choose to make an offer, that the transaction will ultimately close. Since realtors are commissioned employees, they also want confidence that their limited time will be spent identifying homes the borrower is qualified to purchase.
Enter the pre-approval letter, a document created by lenders to help provide this confidence. The pre-approval has become a required component of any offer to purchase residential real estate. While the concept makes sense, the document as it is currently produced is often inadequate and in some cases, actually harmful to the consumer. In fact, a shoddy pre-approval can lead to large financial losses including forfeited deposits, appraisal and inspection costs.
Since pre-approval literally means “at a stage before approval”, being told you are “pre-approved” for a mortgage is only slightly more enlightening than being told the holes in your IKEA furniture come “pre-drilled” — neither guarantees the final product will be constructed to your satisfaction. A homebuyer shouldn’t care about whether they are pre-approved but instead should concentrate on whether they are financially qualified to purchase a particular home.
Unfortunately, the industry cannot even agree on consistent naming of the pre-approval, never mind an acceptable process to actually create the document. Take note of the following from the Consumer Finance Protection Bureau (CFPB):
Some lenders may use the word “pre-qualification,” while other lenders may call the letter a “pre-approval.” In reality, lenders’ processes vary widely, and the words they use don’t tell you much about a particular lender’s process.
Yes, lenders’ processes to generate pre-approvals vary widely, but should they?
The answer is an emphatic “no.” Because nearly all lenders qualify borrowers using universal guidelines provided by Fannie Mae or Freddie Mac, there should be little to no variability in how these pre-approvals are generated. While some institutions do have a fairly rigorous system which includes the prospective borrower providing income and asset documentation, others grant wide latitude to their loan originators to create the letters. In these cases, gathering very limited information from the customer (often only a credit check and sometimes just a verbal request of income) has become the norm.
So, why is there no standardized approach for what should be a very standardized document? Our view is that the pre-approval charade has reached the point where the pre-approval process benefits lenders more than it does consumers.
Imagine if every lender followed the same process and a pre-approval letter from a national bank was produced in the same manner as one from your local community bank or mortgage company. If that were the case, a borrower could truly shop for the best rate versus being stuck with one lender, simply because that lender issued the pre-approval letter.
While it is possible to get pre-approved at one lender and then apply and close a loan with another, it is far more onerous than it should be. Therefore, the vast majority of borrowers stay with the lender that issued their pre-approval, forgoing their ability to shop for the best terms.
It is both unfortunate and astonishing that borrowers are so limited in their ability to effectively shop for the largest financial transaction of their lives but we are confident that this shortcoming can and will be addressed by technology.
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