A Strong Buyer Ready for Action takes these 2 steps first:
- GETS PRE-QUALIFIED AND THEN;
- GETS A PRE-APPROVAL LETTER FROM A LENDER.
Your pre-qualification letter is like taking a practice test whereas your pre-approval letter is taking an actual test and passing.
- WHY GET PRE-APPROVED?
(your unofficial initial snapshot)
- THE ADVANTAGES OF PRE-APPROVAL
- AFTER YOU'RE PRE-APPROVED
- LOAN COMMITMENT LETTER
- LOAN TO VALUE RATIO
- LOW APPRAISAL AND YOUR OPTIONS
- LOW APPRAISAL AND YOUR APPROVAL
- WHEN WILL A COMMITMENT LETTER BE ISSUED?
- LARGE DOWN PAYMENT / LOW APPRAISAL
- WHAT IS CLEAR TO CLOSE?
- CASH BUYERS
WHY GET PRE-APPROVED?
A pre-approval letter will put you in a strong buying position. If you’re a serious buyer, getting pre-approved is very important. With a pre-approval letter, you're almost always viewed as a strong legitimate buyer. In the current market, you may run into more than one buyer putting in an offer on the same house. If your offer is up against a cash buyer or a buyer with a pre-approval letter, you don't stand a chance of the seller taking your offer over either of the other two.
A pre-qualification letter should be your first step ahead of getting a pre-approval. If your numbers come back as expected, then go through the pre-approval process. The reason that a pre-qualification letter is not as good as a pre-approval letter is because the pre-qualification is not official. The Pre-approval process will confirm you're solid or it will uncover issues, some of which you may not realize exist.
If you don’t get pre-approved, you may be wasting your time, the seller’s time, and everyone else’s time who’s involved in your buying transaction. Some Brokers, with Seller permission, won’t even accept an offer unless a pre-approval letter accompanies the offer.
As long as the pre-approval process successfully confirms your buying power (no hidden negatives), you’re now a strong buyer ready for action! House hunting can be fun, but before you get deeply involved in your search for the perfect home, KNOW YOUR BUYING POWER!
STEP 1: PRE-QUALIFICATION (your unofficial initial snapshot):
You’re going to provide a snapshot of your financial situation either verbally or in writing. The lender will apply ratios to the numbers you provide. An agent can do this as well, but if done by a lender or mortgage broker, in my opinion, it adds more credability to the buyer's intention to purchase. The point of a pre-qualification is to confirm the amount of a mortgage you can expect to be approved.
Once you have been pre-qualified, your agent can start to set appointments for you to see houses. At the same time, you’re going to begin step 2 (pre-approval). Keep in mind, I'm assuming that you're a serious buyer.
STEP 2: PRE-APPROVAL (official, but not committed approval by lender):
If the pre-qualification phase is within an acceptable range for you (a loan amount that allows you to purchase property), then go ahead and get the pre-approval step completed.
This is where you’re going to provide the lender with proof/documentation of your financial situation. The lender will officially verify all of your information including a thorough credit check. If you pass their requirements, the lender will give you an official approval showing how much money they will lend you. This doesn’t bind them to lending you the money. If anything changes in your financial situation, the whole approval process may have to be restarted (see After you get pre-approved below).
THE ADVANTAGES OF PRE-APPROVAL ARE SIGNIFICANT:
First of all, you will know your TRUE buying power. You won’t be wasting your time, your agent’s time or the seller’s time! This is really important for everyone.
2nd, If you find the house of your dreams and you make an offer to buy, your offer will be considered stronger than someone who hasn’t been pre-approved. In fact, if another party puts in an offer for more money than your offer, but they haven’t gone through the approval process, a seller will often choose to sell to the buyer who already has the approval.
If you’re up against a cash buyer, your offer will have similar strength. If you offer more than the cash buyer, the seller will probably accept your offer.
You won’t have to go through the whole mortgage documentation process since most of it is already done. The lender will take another look at your situation to see if anything has changed, but assuming it hasn’t, the process is mostly done. Of course, your lender has to make sure that the house you’re buying has proper value ratios etc., but the hard part of the mortgage process for you is already done.
Your pre-approval has qualified you for a loan amount. Brokers and Sellers will take your pre-approval letter seriously. You passed your loan worthiness test!
AFTER YOU GET PRE-APPROVED:
- Don't make any large purchases
- Don't buy or lease a new car
- Don't buy a new boat
(You're looking to move to or are in Florida so you may want a boat - don't buy it yet!)
- Don't open or close credit lines
- Don’t accept $20K from Aunt Lucy without notifying the bank first and getting their feedback.
- Don’t do anything that changes your credit situation!
- A parallel job change should be ok, but first speak with your point of contact before making the move. Changing jobs can have a negative effect on approval.
- Dont change banks or financial institutions. If you have a reason to do so before your purchase, speak with your point of contact first.
Any changes that you make after you’re pre-approved can cause you to have to re-do the approval process.
Almost all lender commitment letters will be for a specific property and will be contingent on the property's appraised value vs loan amount (aka Loan to Value Ratio), property condition, timelines and any other
requirement your lender may include. This is normal so don't sweat it.
One of the contingencies will be that the property appraises within an acceptable loan to value ratio. If the property doesn't appraise, then you have options.
LTV (LOAN TO VALUE RATIO)
The Loan to Value Ratio is the percentage of the appraised value that makes up the loan. Put another way, LTV is a measure of the risk a lender takes when deciding to approve a loan. If you default, the lender expects the mortgaged property to have enough value from which they can recoup their money.
If you made a $60,000 deposit on an agreed price of $600,000 for a property, the LTV is at this point 90% and your loan is for $540,000 (excluding the cost of the loan and other potential additions.)
If the appraisal ordered by your lender comes back with an appraised value of $500,000., the LTV would be 108%. If you default, your lender has zero chance of recovering the amount they lent you. The property value at this point is not high enough for your lender to recover their money. The only winner in this situation would have been the seller. Your lender will not lend you the money.
LOW APPRAISAL AND YOUR OPTIONS
If the property does not appraise, you can either:
- PUT MORE MONEY DOWN
- THE SELLER CAN LOWER THE PRICE
- YOU CAN BOTH CONTRIBUTE
- OR, YOU CAN WALK AWAY
In case you're wondering, there are reasons that people are willing to pay more than the appraised value. It's actually common.
On the flip side, many people view a low appraisal as a warning that they've made a mistake on price.
Depending on the down payment, the appraisal may never turn up a red flag for a buyer. The lender is only concerned with getting their money back if you default.
Therefore, if you're putting 50% down, even if the appraisal is way below the purchase price, the lender will give you a mortgage if you qualify.
LARGE DOWN PAYMENT / LOW APPRAISAL
A good buyer's agent will verify if the property is priced right regardless of your deposit, but it's very important if you're putting down more than 25%. I always evaluate price for my clients (sellers or buyers) so that my clients or office related clients (I'm the go to guy for pricing), understand if the property is priced correctly. Sellers can choose to overprice, and buyers can choose to overpay, but at least they know my opinion of their offer or asking price. Correctly pinpointing price is one of my strong points and should be one of your agent's strong points as well.
Your lender will only lend to you if the property falls within an acceptable value as determined by their Loan to Value requirements. Your lender doesn't care if you overpay for a property as long as they can recoup their money if you default. If you are concerned that you are overpaying, and if you're putting down less than 25%, the appraisal ordered by your lender will become a hurdle to funding if the appraisal comes in lower than expected.
COMMITMENT LETTER WILL BE ISSUED AFTER:
- You have a sales contract signed by all parties
- and, the lender has an appraisal done
CLEAR TO CLOSE
The best part of your loan commitment is when you hear that you are clear to close! That means all contingencies that the lender included in their Loan Commitment Letter (Terms of the commitment) have been satisfied. You are now ready to be funded.
If you're a cash buyer, DO NOT RELY ON AUTOMATED PRICING MODELS that you see online. Get a Broker's Price Opinion or an independent appraisal. If you're making an offer, include an appraisal clause in your offer even if you do not ultimately get an appraisal done. Just make sure that whoever you hire to represent you knows what they're doing when pricing a property for you!