Updated from an article that first appeared on November 2012
Mortgage pre-approvals are pretend documents. It is true that preliminary mortgage approval is an essential first step in the home buying process as real estate agents and sellers want proof of a buyer’s ability to secure a mortgage and bid on a property. Buyers want it to know what their buying power is and what their potential payments and costs will be. Mortgage people see it as the first date in the courting process with new buyers. Everybody sees it as a good idea, a prudent and powerful first step on the oft perilous journey to homeownership. So what’s the problem?
The fact is that mortgage pre-approvals are not what everybody wants them to be. They are not ironclad, they are not processed and reviewed by underwriting people and they are not subject only to an appraisal, even though most of them say that. They are however part of almost every real estate deal and they have become essential in the bidding on a house process. Since mortgage pre-approval has grown to be so integral to the home buying process, it makes sense that lenders would rigorously address this void. Not so.
Back in the day (1980s, early to mid-1990s) there was mortgage pre-qualification and it was done by real estate agents. There were no credit checks and interest rate factors were used to determine monthly payments. Qualifying ratios were calculated to determine buying power and forms were used and blanks filled in to see what buyers could afford. That was the pre-approval process. No mortgage people were involved. That was back when the mortgage business was more of a well-kept secret, and mortgage reps were relatively scarce.
With the rise of the mortgage lending industry in the late 1990s and the dawn of the 21st century and the proliferation of mortgage originating sales people, mortgage pre-qualification shifted from real estate agents to mortgage reps. Smart real estate people deputized mortgage reps hungry for referral opportunities, to shoulder this function, leaving real estate agents to focus on the business of selling real estate. Mortgage reps seized the opportunity to fill this role and mortgage pre-qualification began a rapid process of evolution.
Mortgage reps were primarily sales people, even though their business cards said “Loan Officer” or some variation on that theme, financial skills and training were usually secondary. That being said, mortgage financing was far from rocket science and the financial skills necessary to be a well-qualified and highly effective “Loan Officer” were easily learned on the job. So when mortgage pre-qualification became a sales tool for mortgage reps, there was no uniform process for determining and issuing these coveted golden tickets. Not every mortgage rep did a credit check and the process was usually no more than a telephone conversation and a few mortgage calculations.
At the time, mortgage loans were hand written and manually approved; automated underwriting algorithms and credit scores were not yet part of the mortgage landscape. Some of us had cell phones, all of us had pagers, and the whole process was a little sloppy. Mortgage pre-approval was relegated to a low priority function and the quality of the vetting process and the resulting finished product suffered.
But as 21st century mortgage technology accelerated, so did the proliferation of easy-to-get mortgage financing. The rise of Wall Street securitization of MBS (Mortgage Backed Securities), created an almost limitless variety of mortgage products and a market where everybody got approved. Pre-approval was automatic because regardless of the borrower profile presented, a mortgage product could be found. Remember, this was when income and assets could be pretend because verification was not a requirement, marginal credit was just fine thank you, down payments were unnecessary because 100% plus financing was available in a variety of forms, heck you didn’t necessarily even need a job to get a mortgage!
Needless to say, the mortgage pre-approval vetting process grew even more suspect.
Then in 2008, it all collapsed. Defaults, foreclosures, loan buy backs and billions of dollars of bad loan losses changed the mortgage underwriting process forever. Enter the age of the double and triple checked, redundantly verified, every nook and cranny financial detail examined era of mortgage loan approval. Should be sufficient, compelling argument, make sense documents would no longer be considered.
Paystubs and W2s used to be sufficient income proof for salaried people, but now tax returns were added to the mix to sniff out deal killing unreimbursed employee expense write-offs. Unidentified deposits into asset accounts now require sourcing evidence to determine origin eligibility. Absent the ability to document where the money came from, the asset is eliminated even though the money is right there in the account. Unless these mortgage approval land mines are fully vetted in the preliminary approval process, purchase contracts live in fear of never closing.
The roadblocks dogging a fix to this dilemma are several. Mortgage people rarely ask potential borrowers to fax or e-mail supporting documents during the preliminary approval process. Information describing employment, income and assets are tendered during a telephone interview, an electronic file is created, a credit report is secured and an algorithm delivers an automated underwriting decision. That’s the process. This is precisely when the evidence documents should be requested and gotten, but rarely does that happen. Borrowers are wary of sending tax returns and paystubs and bank statements to a mortgage rep to secure preliminary mortgage approval, because they are not in the lender choosing phase of the process, all they want is a pre-approval letter. Often, the pre-approval call is the very beginning of the lender courting process and most borrowers don’t like to kiss on the first date.
Even when critical decision making documents (tax returns, paystubs, bank statements), are secured early in the game, there is one significant asterisk that prevents mortgage pre-approval from being what everybody wants it to be, and here is where the con comes in. Mortgage pre-approvals are done by loan officers, not by underwriters. Loan officers source and originate mortgage loans, they collect your information and your documents and submit your mortgage loan to a team of processors and underwriters, loan officers do not have the authority to approve your loan. These processors gather, organize and confirm your information, then give your file to an underwriter for approval. Underwriters are trained and anointed with the authority to give final approval to your loan.
An underwriter has not approved and issued your mortgage pre-approval, your loan officer did. There is no processing of the preliminary loan file and there is no underwriting review. There is automated underwriting, there is loan officer review and there is hope that a high level of thoroughness was thrown in. Underwriting guidelines are many, and it is the charge of the loan officer/mortgage rep to completely anticipate barriers to approval before signing off on a deal making, everybody’s counting on it pre-approval letter.
And that is about as good as buyers and sellers and real estate people can expect it will ever be. Lenders are reluctant to deploy resources and manpower to elevate the mortgage approval beyond what it is now. Staffing logistics for underwriters and processors are difficult to balance between demand and profitability models and the mortgage lending industry has not yet found a way to justify the manpower cost of processing and underwriting pre-approvals.
At the end of the day, the best that we can hope for from a pre-approval is that the buyer or borrower has been well vetted and deemed mortgage-able. Beyond that, it is a roll of the dice.
