What good is a pre-approval…and why are agents always trying to make me get one?

If you’ve been in contact with a real estate agent lately (or even spent some time on a real estate website), you’ve probably seen a lot of talk about “getting pre-approved” or “you need a pre-approval.” A pre-approval is vital in today’s market (and in any market in my opinion) to finding the home you want, the home you can afford, and the home you can get under contract without losing it to someone else.

“Pre-approval” is a letter from your lender stating you are pre-approved to buy a home for a certain price. Does it guarantee you’ll get the loan? Not necessarily, but it does improve your chances.

What’s the process?

Pre-approval begins with you speaking to a lender. They will collect information about you, your current living situation (buying or renting), job history, your social security number, and run a credit check to get your FICO score (also known as your credit score). Lenders vary on how they go about the process, but the basics remain the same. Some lenders will do it over the phone while some want to sit down with you and require you to bring certain paperwork (pay stubs, W2s, bank statements, etc.) along with you.

By checking the basics of your employment, financial statements, and credit score, the lender begins to get a picture of who you are as a credit holding member of society. Do you have constant late payments or are you always on time? Have you been employed steadily for a week or 10 years? Do you have any tax liens or judgements against you? Have you ever filed bankruptcy? Do you have a large bank account showing a pattern of savings or is your account always teetering on being closed for insufficient funds. Is your outgoing debt higher than your income or are you debt free? These are just some of the things lenders are looking for when you seek pre-approval.

Most lenders use various computer programs to get your pre-approval. They plug in the numbers and the software runs it through its algorithms to determine if you’re pre-approved. There are times when the software comes back on the edge of one decision or another and then the lender can step in and get the loan manually pre-approved.

In the end, you’ll wind up with a thumbs up or thumbs down and a dollar amount of the loan the lender feels you’re qualified for. A good lender will also sit down with you at this point and discuss your goals and options in buying a home. You might be approved for a $200,000 loan, but because you’re trying to save some money for the future, they might recommend you only buy up to $150,000 to keep your payments at a level you can afford (and have money left over to put away).

So why do real estate agents care about what I’m pre-approved for?

We as agents do care about the pre-approval – very much so. It is one of the most important steps in our first few meetings with a client. The pre-approval process provides us with several things, some of which are crucial to us doing our jobs and providing you with the best experience.

First, the pre-approval process gets the ball rolling. Many buyers like to take their time perusing listings on the internet, going to open houses, or “just looking.” The pre-approval process is a defining moment in the search process. It gets the buyer into action mode and sets the agent’s sights on the next steps.

Second, it allows us to pinpoint what you can spend as we look for what you’re looking for. You tell us you want a 5 bedroom house in a certain community, but we now know that a 5 bedroom in that community is out of your range – we can help you make firm, educated decisions. You might have to settle for the 4 bedroom in that community, but we know of a nearby neighborhood that has a 5 bedroom that fits your price range. We hate to see a client falling in love with a house that we later find out they can’t afford. I certainly don’t like to be the bearer of bad news.

Third, I don’t know any listing agent (or banks or HUD) that will take an offer without a copy of a pre-approval letter. Without one, there is no sense in submitting an offer, because it will just get turned down. The seller wants to know that when you say “I’d like to buy your house,” you can afford it and they won’t be stuck scrambling to find another buyer when you get turned down for a loan.

And what benefits does it have for me?

Most lenders will lock in your rate for 90 days, allowing you to get pre-approved now and take advantage of today’s rate instead of the rate three months from now. Now of course, interest rates can be volatile and change on a whim. Because of this many lenders offer what is called a “float down.” This allows you to lock in today and move your interest rate to a lower one if it becomes available during the period between locking in your rate and the actual purchase of your home. Typically, a lender will only allow you to do this once, so you must choose wisely.

It gives you a road to recovery if there are any problems. Many people have credit problems. Its not uncommon during the pre-approval process to uncover a debt that has long since been forgotten, mistakes on your credit report, or even someone else’s credit history appearing on your report (my dad and my brother had some cross reported items as they share the same name). By getting approved now, there will be no surprises later. Many people just need some simple adjustments to boost their credit score (allowing them to buy more, at a better rate, or push them over the edge towards being approved).

So I have a pre-approval – that means the “money’s in the bank”, right?

No. Although a pre-approval is about as close to getting a loan as you can get (without being handed a big pile of cash), it is not a guarantee. Your loan is still conditional upon you meeting the requirements of the loan. This is a great time to not apply for new credit, charge anything to your credit card, go buy a new car – anything that will add debt to your credit report is a bad thing right now. Just hold tight and wait to get the keys to your new home before buying all that new furniture or a shiny new red convertible. During the process of buying your new home, the lender will re-check your credit towards the end of the process as well, so you want to look as good to them on paper as you did when you first got your pre-approval.

The lender will probably ask for a lot of paperwork during the loan’s actual approval and getting it to them in a timely fashion will help alleviate any unforeseen problems. Underwriters (a whole other blog post) are notorious for asking for additional information during the approval process and it can seem frustrating, but just remember – they’re taking a risk by giving you a large sum of money, so they have to cover all their bases too.

Pre-Qualification vs. Pre-approval.

Pre-qualification is similar to pre-approval, except it relies on you giving the lender the facts about your income, debt, employment, etc. without any real verification. It seems to be going the way of the dinosaur and is pretty useless these days. It used to be you could make an offer on a house with one, but anymore no one wants them. If given the choice (which is rare), go for pre-approval as it is a much stronger statement of your financial situation.

One final note…

When a lender pre-approves you, have them send a copy to your real estate agent for their files. This will make an offer a quick and easy process and you won’t have to go find the letter when you need it most. Of course, when making an offer, your agent will try to contact the lender and get a pre-approval letter written so that it reflects the offer price. There is no need to show your hand when making an offer and suggest to the seller that you’re offering this much, but could afford and are pre-approved for much more.

photo courtesy of Toolstotal