Mortgage Pre-Approval is Still Worth Getting

The majority of home-buyers conduct their house-shopping before obtaining financing. After all, how can you obtain a loan for a property that you have not yet purchased?! What if I told you, however, that you could achieve a loan guarantee from a prospective lender at the beginning of the process, such that you could close on the purchase of a home immediately after selecting it?

Known as pre-approval, this guarantee represents a commitment by a specific lender to underwrite a mortgage for the potential purchase of a home. Based essentially on your credit score and a handful of other selected financial characteristics (pertaining to your assets and income), the lender will determine the maximum monthly payment you can afford to make. Prevailing interest rates are then applied to this figure in order to determine the maximum overall mortgage amount.

The advantages of pre-approval are two-fold. First of all, you can shop for a home with the confidence that you can obtain financing for it as long as it falls within the financial specifications laid out by the lender. Second, the pre-approval letter can be used as a bargaining chip in negotiations with the seller. For example, if two potential buyers make similar offers for the same property, the seller might be more willing to accept the offer from the pre-approved buyer, because it is more likely that the sale will close quickly. The advantage to the lender is that the borrower is more likely to return to it when he begins the actual process of obtaining a mortgage.

Unfortunately, it seems that lenders are now reluctant to grant pre-approvals, as part of a general trend towards stricter lending standards: “The rules from the Department of Housing and Urban Development require lenders to issue a binding good-faith estimate of total closing costs within three days of submission of a formal loan application.” In other words, it is not so much the pre-approval itself that frightens lenders, but rather locking in the closing costs.

Instead, lenders are turning to pre-qualification, which is “a less rigorous assessment of how much they can afford to borrow based on unverified financial data.” In such cases, a pre-approval might only be granted after the borrower’s loan application has been formally reviewed. While a pre-qualification is useful in that it gives the borrower a reasonable idea of the maximum loan they can hope to obtain, it is ultimately non-binding and thus, unreliable. Even if it is based on the same underwriting standards, the fact that it is only a pre-qualification means that a lender is not legally bound to it in the same way it would be to a pre-approval.

Borrowers should ultimately be aware of this distinction and push for a pre-approval. Most lenders should theoretically still be willing to issue them; it might just be a matter of persistence and understanding the process for applying for them.