Buyer Question – What’s the difference between prequalification and preapproval with a lender? Why do I need to be pre-approved before I’ve found a house? Should I trust a lender that’s advertising on TV?
Years ago, the buying process started with a Realtor® showing homes to a potential buyer, and in most cases, there was a good number available. It might take several outings, but they’d decide, and the buyer’s agent would write an offer and present it to the seller’s agent. Negotiations ensued, and upon agreement, everyone signed the contract. Now it was time for the buyer to go off to their local banker and ask for a loan. If declined, the seller gave a big sigh and then put their house back on the market and tried again.
In recent years, the process has changed dramatically, especially in Johnson County, KS where I live. We seem to be perpetually in a seller’s market, where there are never enough homes for potential buyers. Today, most listing agents recommend their clients don’t even consider an offer unless a potential buyer says they are preapproved. A letter from a lender, submitted with the offer, substantiates preapproval. Of course, what the seller’s agent is trying to do is ensure that the potential buyer has the resources to close the sale before everyone spends time negotiating price and suffering through inspections, appraisals, etc.
So, without a letter, the seller simply says, “Next.” With the letter, both buyer and seller relax believing they have eliminated one possible hiccough that could keep the transaction from closing. But to most sellers and even seller’s agents, the problem is jargon. All preapproval letters are not created equal, and some are only prequalification letters.
What’s the difference between prequalified and preapproved? Because lenders get so many requests for preapprovals many have adopted a simple routine and the conversation with a potential buyer goes like this, “How much money do you make? What kind of debts do you have? What kind of money do you have to put down?” They run a quick credit check, but not always and if there are no obvious red flags, the lender issues a letter. More and more this process is even done online and the lender never actually meets with the buyer. But, the buyer believes they have been preapproved and gives the letter to their real estate agent. Such a letter is not a preapproval letter, but a prequalification letter and without some additional checks, it is useless.
“Later during the actual loan process serious issues may likely arise,” says Cindy Breternitz of Wells Fargo in Overland Park, KS. She finds that buyers forget to mention all sorts of things unless she takes the time to poke and prod a little. “They forget they have child support payments. It comes out that they don’t have $10K in the bank for the down payment; they are expecting Dad to loan them the money. They may have cash income that never shows on a bank statement. Another issue that arises is that they are self-employed and haven’t been in business for at least two years. There are any number of situations that may cause loan denial,” she says. “True preapproval requires income and employment verification, W-2s, paystubs, tax returns, a complete credit check, documents showing proof of funds for down payments, etc.”
A seasoned buyer’s agent will check their client’s lending institution to make sure the letter they are holding is the real deal before spending hours and days showing homes, and a wise listing agent will do the same before helping their seller negotiate an offer.
When possible, to avoid surprises I recommend my clients start the preapproval process six months before they are ready to buy. Jennifer Ferguson of the Credit Law Center, a top credit repair company, says, “Statistics show that almost 79% of individuals have inaccurate or unverifiable information affecting their credit scores. Sometimes the negative entries are not even the individuals, but someone else’s and most people are completely unaware until they apply for a loan.” Even if a negative entry doesn’t ultimately cause denial, it will affect the score. A higher credit score gets a lower interest rate, and that can save a buyer thousands of dollars over the life of a loan. Planning ahead allows time for a credible credit repair company, such as the Credit Law Center, to remove negative information before it causes a buyer to lose the home of their dreams unnecessarily. It pays to be proactive.
Lastly is the question of using an internet lender. My recommendation is always to go with a lender that you can meet with face to face and get to know. The competence and dedication of a lender can make or break your sale. I recently dealt with a client’s cloud-based lender and will say that when I called for verification, I was impressed with the knowledge and experience level of the loan officer. But after the initial contact, my buyer was passed on to another department and employee. The company did inform my buyer but did not realize the importance of keeping me, the Realtor®, informed, and my buyer failed to mention the switch. When a problem arose late in the sale, there had been a third shift, and by the time I’d spent several days trying to track down the current associate, we’d almost lost the sale. Very frustrated I told the representative I knew she wasn’t responsible for policy, but it would have been very easy to add my email address to correspondence and keep me in the loop. She was silent, and I could almost see her shrug her shoulders through the phone. She just didn’t care. It was an assembly-line process to her.
In my opinion, a buyer shouldn’t risk one of the biggest purchases of their life to a perfect stranger. I recommend interviewing a lender like you would your real estate agent. And, if you don’t feel completely confident in their abilities and commitment after looking them in the eye, continue shopping around. In the big scheme of things, a buyer is rarely going to save anything by using an Internet lender. I have valued relationships with the lenders I recommend, and I am happy to give you their information.
Cindy Breternitz, Wells Fargo phone conversation 10-16-16
Jennifer Ferguson, Credit Law Center phone conversation 10-10-16
The opinions expressed in these articles are not necessarily those of Executive Life Magazine or the ACA Business Club. Answers are general in nature and do not apply to particular cases.