What the decline of preapprovals means for homebuyers
The mortgage preapproval, for years a crucial step in the home-buying
process, is losing its luster with lenders, new data shows.
A mortgage preapproval is a written commitment lenders give to buyers
that states the maximum size home loan they can get as well as the
likely interest rate. Buyers rely on preapprovals to make sure they’re
shopping for a home that’s in their price range. But new federal data
suggests lenders are scaling back on preapprovals. Among the top 25
mortgage lenders, just 29,912 preapprovals resulted in mortgages that
borrowers received to purchase a home last year, according to data
released last month by the Federal Financial Institutions Examinations
Council. That’s down from 101,626 in 2007, before the housing downturn.
Preapprovals accounted for 4% of purchase mortgages that were originated
by these lenders last year, down from 9% in 2007.
In addition, preapprovals—which have traditionally been considered one
of the first steps to getting a home loan—did not precede any of the
mortgages doled out to home buyers by 14 of the largest 25 lenders last
year. “The popularity of preapprovals is quite low,” says Mike Lyon,
vice president of mortgage operations at Quicken Loans.
(The mortgage lender had 598 preapprovals result in mortgages last
year, down 43% from 2007, according to this government data.)
Andy Dean Photography / Shutterstock.com
The demise of the preapproval comes at a delicate time for home buyers.
As competition heats up, bidding wars are becoming the norm; for
prospective buyers to stand out to sellers, they often need to show
proof that they have lined up financing and are ready to proceed with
the transaction, says Jim Gaines, research economist at Texas A&M
University’s Real Estate Center. Preapprovals provide that evidence to
sellers, and buyers who lack them will have a hard time getting a home
that has many offers on it. Preapprovals may also provide some leverage
to buyers who are competing against all-cash buyers, who accounted for
32% of existing-home sales in August, up from 27% a year prior,
according to the latest data from the National Association of Realtors.
Because they don’t need a mortgage, all-cash buyers often make lower
offers on homes; a home buyer with a higher offer and a preapproval
could beat them out, says Gaines.
To be sure, this government data may not encompass all preapprovals. The
numbers are released under the Home Mortgage Disclosure Act, which
requires lenders to submit their mortgage and preapproval numbers to the
federal government. Some lenders say they don’t submit data for their
preapprovals because they don’t meet the federal definition. The
official criteria include a written commitment to give a home loan for a
certain period of time, with the caveat that approval can change only
for a few reasons including a change in the home buyer’s financial
standing or some other conditions that could derail a sale, like a
report of termites in the home.
Housing experts, however, say the decline in preapprovals is largely due
to dwindling competition among mortgage lenders for new clients. Prior
to the recession, lenders used preapprovals as way to attract would-be
borrowers. Buyers who had this commitment from a lender were more likely
to turn to this company when they were ready to get the actual
mortgage, says Keith Gumbinger, vice president at mortgage-info site
HSH.com. In that way, preapprovals became a revenue source for lenders.
Since the recession, many lenders have shut down, and that has decreased
competition for buyers, he says.
Separately, lower-than-expected appraisals of homes have resulted in
fewer preapprovals, says Gumbinger. Preapprovals are usually given
before buyers identify the home they want to buy. When the home’s
appraisal is determined to be lower than the purchase price the buyer
and seller agreed to, the lender often requires the buyer to come up
with the extra cash to make up the difference; buyers who are unable or
unwilling to do so walk away, and the preapproval ends up derailed.
Several banks, including Chase and Bank of America, say rather than
preapproving home buyers, they’re mostly doing pre-qualifications. With
pre-qualifications, lenders inform borrowers of the size of the loan
they can qualify for based on their stated income and assets as well as
an initial credit check. Historically, pre-qualifications were the first
step buyers would take before shopping, which was then followed by a
preapproval when they became serious about a specific home they wanted
to purchase.
To give buyers a better idea of where they stand, Chase says it provides
a more detailed prequalification program through which buyers get a
“conditional approval” that usually lasts 90 days, which they can share
with the seller. The bank says this type of approval differs from the
federal definition of a preapproval because it is not a written
commitment; instead, its commitment is often delivered after verifying
borrowers’ income, employment and the home’s appraisal. Similarly, a
Bank of America spokesman says the bank wouldn't approve a buyer until
the home is appraised and the borrower’s financial condition is fully
vetted.
A prequalification doesn’t provide the same leverage to buyers though as
an official preapproval. Pre-qualifications are typically based on
average mortgage rates rather than the rate that’s close to what the
borrower would actually get. Also, most lenders can rescind a
prequalification, whereas a preapproval is a commitment that usually
lasts two to three months.
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