Why do I need a preapproval letter to make an offer on a home?

The San Jose, Silicon Valley real estate market is once again heating up.  The current housing market frenzy is  due to the availability of low interest rate loans, high buyer demand, and a very low number of homes on the market.  More and more, buyers are finding themselves in multiple offer situations. A pre-approval letter from the buyer’s lender will help improve the chances for offer acceptance.  Many of the offer requirements have been tightened as a result of the busted housing market and now stricter underwriting approvals.  Bank owned properties recognized many buyers would write high offers simply to get their foot in the door only to find out they did not qualify for the loan.  Wasted time off the market, while prices dropped quickly, made all sellers realize qualifying buyers was a key to a successful transaction.  Beyond a pre-approval letter, many sellers also want to see the buyer has the cash to close.  This means copy of bank statements or stock accounts that show cash balances that equal the down payment and closing costs needed to close the deal. The earnest money deposit check of 3% is also a typical requirement as well, although in my humble opinion it is meaningless unless a proof of funds is demonstrated. (NOTE: Whenever you provide documentation of personal accounts, blacken out account numbers.)

Pre-approval letters are varied and some listing agents also request on behalf of the seller, desktop underwriting, and/or conditional approval.  At times it gets ridiculous.  Desktop underwriting is simply a computer program that allows the agent to input numbers and generate an approval.  Garbage in and garbage out.  Until the file is front of the underwriter, any computer generated approval is simply a preliminary assessment.  Conditional approvals are not possible without a purchase contract and therefore are a silly demand and impossible to present in reality on an offer.  At a minimum, a pre-approval letter should indicate proof of funds have been confirmed, credit scores checked, and a “complete file” has been received.  A compete file includes tax returns, pay stubs, and a complete loan application for all borrowers.  In many ways, a quick phone call to the buyer’s loan officer will answer more questions than any letter.  The information is confidential (salary, debt etc) but general statements about completeness and credit scores can be requested.

A recent New York Times article discussed the pre-approval process.  Here are some of the highlights from that article:

  • The differences between mortgage pre-qualification and pre-approval are significant. Pre-qualifying for a mortgage is based solely on what a borrower discloses to the loan officer or broker about his/her earnings, credit score, and total assets, including what is available for a down payment. By contrast, a pre-approval requires a borrower to provide documentation of his/her income and assets.
  • The lender typically pulls the borrower’s credit report and score, while the borrower gathers together almost everything else needed for the actual mortgage underwriting: W-2 wage statements; 1099s; recent pay stubs; bank statements; and statements from Individual Retirement Accounts and 401(k)s; and other assets that could show the borrower has the resources to buy and maintain a home.
  • At one of the country’s largest mortgage lenders, Wells Fargo, the first quick review provided by an underwriter constitutes an agreement to lend.  Other lenders may treat preapprovals as more of an opinion on the person’s ability to borrow, not a guarantee to lend.
  • The preapproval letter should include the amount a borrower is qualified to borrow, as well as the loan officer’s contact information.  Some letters may have an estimated monthly payment, but details about the loan time and interest rate are not included.
  • Timing also is important.  Buyers should aim for obtaining a pre-approval letter from a lender within 30 to 60 days of the expected purchase date.  That is because some letters expire in 90 days.