In 2018, mortgage pre-approvals are absolutely essential to the home buying process.
- Some real estate professionals won’t work with borrowers who haven’t been pre-approved for a mortgage.
- Sellers rely on pre-approval letters to help determine whether a potential buyer can actually make good on an offer for their home.
- Smart homebuyers get pre-approved for a mortgage before they really get serious about house hunting, because clearing the major financing hurdles early in the homebuying process can save homebuyers hassle and stress.
Given how important pre-approvals are to homebuyers, real estate professionals, and home sellers, most folks would be surprised to learn that many mortgage pre-approvals have a serious problem.
What’s wrong with pre-approvals today?
The short answer: Not all mortgage pre-approvals are equal.
Sometimes Pre-Approval Doesn’t Really Mean Pre-Approval
Just like food labeled all natural, there’s actually no universally-agreed-upon, regulated definition of what ‘pre-approval’ means when it comes to mortgages.
Most lenders and brokers use the term pre-qualification to describe the sort of quick, plug-a-few-numbers-into-a-calculator-or-spreadsheet process borrowers can use to get a very rough idea of whether they might qualify for a mortgage.
You make $X per year and have Good/Great/Excellent credit? You may qualify for a mortgage up to $Z! Click here to find out more…
Similarly, most lenders and brokers use pre-approval to describe a more in-depth process, where the lender or broker takes a look at your financial situation and some verifying documents and tentatively approves your potential mortgage application based on the information you provided.
That said, these terms aren’t set in stone. Not every lender or broker uses pre-approval and pre-qualification to mean the same things. One lender’s pre-qualification might be equivalent to a different lender’s pre-approval. A different lender or broker might call the process something else altogether.
The different names for the process aren’t that important, of course.
But there are still some unscrupulous folks out and about in the mortgage world who use the term ‘pre-approval’ a lot more loosely than most folks in the mortgage industry, convincing unwary would-be homeowners that they are already approved for a mortgage, even without any verified financial information. (There aren’t a lot of those folks anymore, thankfully. But mortgage borrowers still run into them from time to time.)
And discovering that you aren’t actually good to go with your home financing when you thought you were can be incredibly upsetting, especially when you’re trying to close on a home. In a worst-scenario, a delayed or (gulp) rejected mortgage application can mean a deal falling through entirely.
Documentation requirements for mortgages are regulated and standardized. But documentation requirements for mortgage pre-approvals are not.
Because lenders and brokers can play fast and loose with the definition for ‘pre-approval’, they can also choose what documents or details they want to see from borrowers before they’ll ‘pre-approve’ them for a mortgage.
Now, there are actual rules and regulations concerning what lenders are required to collect and verify from potential borrowers before approving them for a mortgage. But that’s only for the final step.
Because pre-approval is only an intermediate step in the mortgage process, requirements can vary pretty significantly from one lender or broker to another as to what sort of evidence potential borrowers need to provide in order to get pre-approved for a mortgage.
For example, lenders are required to verify both the amount and the source of a borrower’s income before finalizing a mortgage. But how a lender or broker chooses to address the ‘verify income’ requirement during their pre-approval process can vary.
One lender might ask for copies of a borrower’s W-2 in order calculate her income to pre-approve her for a mortgage. A different lender may ask that same borrower for her tax returns instead. Still, another may only ask the borrower how much her annual salary is, trusting that the borrower will be able to back up her salary figure later.
Let’s say we have a borrower whose W-2 and tax returns include a year-end bonus. Bonuses definitely count as income for tax purposes, of course.
But a bonus doesn’t count as regular income when it comes to your mortgage: if you can’t count on that money, year-in, year-out, a mortgage lender won’t use that money to calculate how much you’ll be eligible to borrow for your mortgage.
If a lender pre-approved our imaginary borrower for a mortgage based only on the income reported on her W-2, that borrower would be in for a rough surprise during the final underwriting process for her mortgage: with a lower official income (without the bonus) she would qualify for a smaller mortgage than her pre-approval might have suggested.
And if our imaginary borrower was trying to buy a home on what she thought was the upper end of her price range? She’d be out of luck.
So what should a savvy homebuyer do?
A home is the largest purchase most of us will ever make: it’s important to get the financing right. At Morty, we think the mortgage process should be simple. That that begins with a pre-approval process that’s quick, thorough, and reliable. As a homebuyer, educating yourself about the mortgage pre-approval process is the first step. You can learn more about mortgage pre-approvals in our ongoing pre-approval series. And when you’re ready to begin on your home buying journey? You can get started with your Morty pre-approval here.