Mortgage originators mean well when working with their clients, and it’s understandable that many want to get potential homeowners jazzed about making a home purchase. But there’s a certain practice that’s creating bad blood in the mortgage business.
That’s when originators prequalify their borrowers while not explaining fully that it’s not the same as getting preapproved. In fact, it’s causing confusion within the market and, in the end, it doesn’t benefit your borrower. Preapproving them, however, would be beneficial.
When a homebuyer gets prequalified by their lender, this is how it normally goes: Your borrower found their dream home. They’re ready to act now. Luckily for them, they already have a prequalification letter and put an offer in on the home. They’re soon told they have won the bid.
Now comes the fun part — going through the under- writing process. The buyer works to get you all the documents you need when suddenly you hit a snag: their credit score is too low. There’s no way you can finance the home for that price, and they lose the deal. Dream crushed.
That’s only one possible scenario among many when borrowers are prequalified rather than preapproved. Some borrowers don’t even make it that far in today’s competitive market as their prequalification letter isn’t taken seriously and they don’t win the bid on the home. There’s an even larger argument currently underway, too: Prequalifying borrowers not only misleads them, it does little to satisfy current underwriting standards.
Many consumers and lenders use the terms “prequalified” and “preapproved” interchangeably, but there are several important differences between the two. The consumer may not know what they are getting with a prequalification letter. The originator, however, does.
Prequalifications occur when the borrower gives a lender information about their income, debts and assets. Based on this information, the originator gives an esti- mate of the price range the borrower can afford or qual- ifies for, then gives them a prequalification letter for this amount. Prequalifications do not, however, run the borrower’s credit or check any financial information beyond what the borrower verbally communicates.
Preapprovals, on the other hand, are an actual commitment for an exact amount to grant the borrower a mortgage. For this step, borrowers must submit documentation to prove their financial situation, and originators perform an extensive check that looks at a borrower’s background and credit score. It presents a more serious commitment to the borrower, which better reflects on the mortgage market as a whole.
Prequalifications, as previously mentioned, do not offer any help toward originating a loan with full regulatory compliance. Preapprovals, on the other hand, provide the verified personal information necessary for a loan to be correctly underwritten.
Lack of commitment
If preapprovals provide a real commitment, then why would anyone want to get prequalified? There are actually several reasons originators give when saying that prequalifications make more sense.
For example, if a first-time homebuyer is just browsing and wants to know what they could afford, but they aren’t ready to commit to buying a home, they might want the prequalification. Once they get preap- proved, this process will check their credit and affect their credit score.
If the buyer isn’t ready to buy a home within the next 90 days, some argue a prequalification could be the more appropriate choice. It provides an idea of what one could afford, with no negative side effects or commitments from any party. Although the argument can be made that prequalifications are a better choice in some situations, a closer look reveals why preapprov- als go a step further in keeping the mortgage under- writing in line with current regulatory-compliance standards.
Many consumers worry about checking their credit because of what it will do to their credit score. It is true that checking your credit could lower your score, and many consumers fear shopping around when it comes to getting a mortgage or buying a car.
This is a common misconception. Most often, multiple mortgage or auto-loan inquiries within a short period of time will simply be lumped together as one credit inquiry, as it is obvious the consumer is shopping around, not drawing on multiple lines of credit.
The only thing a prequalification does is create confusion.
This means it actually wouldn’t hurt a consumer to get preapproved, even if they aren’t quite ready to buy a home. And with preapproval, originators could have a more in-depth understanding of the borrower’s finan- ces. This allows originators to advise their clients about financial planning so they can improve their situation and qualify for a higher loan amount or lower rates.
The only thing prequalification does is create confusion. In an industry that is already difficult to navigate, consumers are confused by the two terms and exactly what each one means. Giving a prequalification slows the mortgage origination process and makes a bor- rower less competitive, thereby making them less likely to win a purchase bid — even though they think they’ve taken all the necessary steps to make their offer competitive.
When originators give out prequalifications, it’s like giving an imitation approval. There’s no real data or information behind it, and the originator really has no idea if the borrower can qualify for that amount. The only real purpose prequalification serves is to inform the borrower, which preapproval also can do.
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The argument can be made to call for legislative action that would ban the practice of prequalification altogether. That won’t happen until all mortgage brokers and loan officers join the chorus against using prequalifications.
Federal legislation would create a less confusing market, and keep borrowers informed using real data and information. It is vital that originators use preapprovals to help their borrowers truly understand their financial situation and give them a more secure commitment as they begin their home search. Originators owe it not only to their clients, but to themselves as well.