November 18, 2020
By Saeed Ghaffari
(A must read by first time home buyers and new agents)
A mistake some real estate buyers make is they start looking for homes before talking to a lender, leading to disappointment, as they often look at the properties out of their reach and they get the disappointing news after they start their loan application.
The challenge they face here is the properties in their affordability no longer excites them and it prolongs the home finding process and makes it difficult, not only for themselves but also for the agent working with them. Some blame their agent for his/her lack of ability to find them the right property, changing a couple of agents and exhausting their efforts before one finally squeezes them to a less than ideal property after months and months of chauffeuring them around multiple neighborhoods across town and even sometimes to different cities.
Seasoned real estate agents know better to waste time showing buyers properties, unless they have the proof of down payment and a prequalification or a preapproval letter from a reputable lender. Those who have been around the block a few time, have been burnt with buyers with a full loan approval in their hand a time or two, who could not close their transaction in the eleventh hour.
(I remember a transaction I was involved in the early 90s. I had a first time buyer referred to me for a mortgage loan by a rookie agent. The buyer claimed to have 20% down and the loan program, a negative ARM from the good old World Savings did not require proof of down payment or income. The loan was approved, loan docs were drawn, signed and at the time the buyer was supposed to deposit his down payment, he attempted to use his American Express card, thinking he had unlimited credit with them. How naïve! The deal fell apart at the last minute, finger pointing and blaming one another flew around, until finally the dust settled and buyer lost his earnest money deposit. Ouch! I was not a rookie loan officer and it wasn’t my job to ask for the proof of down when the loan program did not require it, but I should have known better. It was a lesson learned and ever since always made sure buyers had liquid assets or access to them, even though it wasn’t their own.)
The following will shed light on what the prequalification, preapproval and a full approval is and why buyers and realtors should know the difference and be prepared for the unexpected.
A loan application process starts with a licensed loan officer collecting buyer’s information on a loan application, mainly
- assets and
The prequalification act is the process of analyzing the information on the application;
- Reviewing the employment history and structure
- Reviewing source and the type of income
- Calculating the adjusted gross income of the borrower, that is the income before taxes
- source of down payment and all funds available to the borrower, through gifts, sales proceeds of properties, etc.
- borrower’s credit history, scores and checking for major derogatory items such as bankruptcy or foreclosure, making sure they are old and not too recent.
- Reviewing the liabilities on the credit report, the balances and the monthly obligations
- And finally calculating the qualifying ratios, that is the ratio of borrower’s monthly housing expenses and long term obligations to his/her adjusted gross income.
Determining the above information is in line with the loan in request’s guidelines is called a loan pre-qualification process.
The loan pre-approval process is next and that is
- Verification of the information discussed above and
- Inputting the information in an automated underwriting engine and obtaining a computer generated approval, that is the reaffirmation of the qualification reached by a loan officer.
The verification of the loan application information involves collecting supporting documents such as tax returns, W2s, pay stubs, and bank statements or contacting third party entities such as the IRS, banks, employers, CPAs and others to check for accuracy and validate the information received on the application.
The data entry into an automated underwriting engine (AU) and obtaining a computer generated approval is usually the job of a loan processor. Once this step is done and a favorable result is obtained, the loan is considered preapproved.
A full approval process is a job of a loan underwriter, a 3rd person involved in the transaction. And that is reviewing the borrower’s information on the application, the automated approval and additional reports and documents such as preliminary title reports, appraisal report, escrow instructions, purchase agreement and disclosure, and other paperwork. The function of an underwriter is to look for red flags and clues that may hint to the probability of employment discontinuity, drop in income, fraud or misrepresentation of information by borrower, loan officer or loan processor, miscalculation of adjusted gross income and qualifying ratios, errors on appraisal report and title issues, etc.
Let’s summarize the above: Prequalification is the process of analyzing the data/information on the loan application, usually by the loan officer with one pair of eyes and a salesmanship attitude. The preapproval is the process of verifying and obtaining a computer generated approval by a second person and that is the loan processor, usually, a second pair of eyes added to the transaction in a quality control position. And the full approval is the process of underwriting the file by an underwriter, checking details, looking for potential hazards and red flags with a fine tooth comb, a third person in the process, with a detective/inspector attitude reviewing the entire loan package for accuracy, guidelines and compliance.
The moral of the story is that always, there is room for errors in the prequalification with one pair of eyes, a salesman pair of eyes on the file, especially if those eyes are not trained and experienced. The preapproval lowers the room for mistakes by adding a second pair of eyes and bringing some quality control to the picture. And finally, the underwriters have the final say on the transaction, and without their stamp of approval, the transaction is always at risk.
So, before going around looking for homes with a realtor, get yourself pre-qualified, preferably pre-approved with a seasoned loan officer and his team with experienced pairs of eyes on your file to save time and enjoy the process. If and when you face a problem or challenge, before blaming your lender, realtor or others in general, take responsibility for your own short comings and mistakes first and attempt to fix. And if you truly find others responsible for any problems in your transaction, be respectful, diplomatic and smart. You can catch more flies with honey than vinegar.
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