SANTA CRUZ (September 19, 2009) - Unfortunately, when it comes to mortgages, the term “loan pre-approval” has been so misused that the loan pre-approval letter that sellers require often carries almost no validity. The purpose of the loan preapproval is to assure all parties to a real estate transaction (buyer, seller and Realtors) that the prospective homebuyer who is making an offer has the ability and capacity to provide the cash to cover the down payment and closing costs and the income, job stability and credit to obtain the mortgage necessary to buy the home. The pre-approval letter should not represent merely a cursory review of this information but an absolute credit approval subject only to the borrower finding a suitable property

In order to obtain a loan pre-approval a borrower needs to present his or her federal tax returns and W-2s for two years, 30 days of current paystubs and bank statements for each account that will be tapped for the down payment and closing costs. The underwriter will review these documents along with a current credit report to determine whether or not the borrower can meet the required criteria. It is called a ‘pre’approval rather than an approval because a loan approval requires the underwriter to also review documents that are not yet available at the time an offer is made (the purchase contract, appraisal and preliminary title report). Pre-approvals are typically good for 60 days and, to be refreshed, underwriters will just need to review updated paystubs and bank statements.

Once the underwriter has received and carefully reviewed the borrower’s financial data, it is input into one of the automated underwriting software programs that is used, nationwide, by virtually every bank and mortgage bank in the country. Although mortgage brokers may have access to these underwriting software programs, they do not have the authority to provide either loan approvals or loan pre-approvals. Even loan officers at banks must rely on their underwriters to provide pre-approvals and since their underwriters are often not in the bank, approvals must come from out-of-county loan centers.

Pre-approval letters lose their validity when loan officers with no authority write them. These letters are more accurately called pre-qualification letters and certainly do not provide the assurance that sellers expect from a buyer as they are reviewing offers on their property.

This discussion would not be complete without commenting on the fact that mortgage guidelines are constantly in a state of flux. The same loan that gets approved by the automated underwriting software today may get rejected tomorrow due to an unannounced guideline change. Furthermore, there are always last minute glitches that can and do occur that could prevent an escrow from closing. For example, on the very day a loan is scheduled to close, the lender will have another look at the borrower’s credit and will also check with the borrower’s employer to make sure they still are working. Any changes in these last minute verifications could delay or prevent a transaction from closing.

This column is written every Saturday by Peter Boutell, Certified Mortgage Planner and a principal at Santa Cruz Home Finance. You may reach him at (831) 425-1250 of email him at Peter@SantaCruzHomeFinance.com.