If you are interested in buying a home, chances are you need a mortgage — and the first step toward a mortgage is a prequalification (or its cousin, pre-approval) letter. You provide your lender with basic financial information, and in return you receive a written offer to provide you with financial backing for a home purchase.
However, buyers — and especially first-time buyers — should know that having a letter in their pocket isn’t everything. In fact, according to statistics kept by the National Association of Realtors, some 16% of realtors recently reported that deals that they had signed contracts on didn’t close.
Here are five things to keep in mind even once you have your pre-qual in hand:
- A pre-qualification letter is a vote of confidence, not a guarantee of financing. That’s why, as a real estate agent, I always advise buyers to put a mortgage contingency clause in their contracts, giving them the right to back out of a deal if their financing doesn’t work out.
- A pre-qual is only as good as your mortgage lender’s (or mortgage broker’s) questions. For example, say you’ve told your lender over the phone that your income is X, but forgot to mention that some of that was bonus. When it comes time to underwrite the loan, the bank might give you full credit for that bonus, discount the bonus, or refuse to give you any credit for the bonus at all. The same holds true for, say, income you make from a rental property. So even though your broker or banker might be asking you tough, detailed questions, remember that the point is to uncover hot spots now, and avoid an eventual turndown later.
- A pre-qualification is a vote of confidence in you, not your target property. “I always write on the bottom of my pre-qualifications “subject to project approval,” says David Breitstein of Apple Mortgage Corp., a New York-based mortgage broker who works with multiple banks. Factors that might stop you from getting your target property include too much investor concentration (it’s tough to resell a mortgage in an apartment building if any one investor owns more than 10% of the building), to much lender concentration (banks don’t want to risk lending to too high a percentage of the building) and lack of documentation (a new house might not have a required certificate of occupancy).
- The more specific a pre-approval letter is, the more likely it will impress the seller. In her excellent mortgage book Homeowners Beware, industry insider Carolyn Warren shows a rewrite of a pre-approval letter. The first draft says, “This approval is for an FHA, 30-year, fixed-rate loan.” The final (and stronger) draft says, “The terms of the 30-year, fixed rate FHA loan are as follows…” and then goes on to detail not only the purchase price, but also the buyer’s down payment. Remember that your mortgage banker or broker is getting paid to make this loan, so it’s OK to ask them to help you generate a strong letter.
- Your target property has to appraise at or near the price you’ve contracted to pay for it. Let’s walk through an example: Say the bank is willing to lend you 80% of a property’s value, and you have a down payment of $100,000 ready to go. That all works out fine if you find a property worth $500,000. But if the bank’s appraiser thinks that property is worth merely $400,000 – they’re only going to lend you 80% of that, or $320,000, leaving you $80,000 short of where you want to be. Your options at this point are to try and make a new deal with the seller, or to bring a lot more cash to the closing table.