By Jack Guttentag
Saturday, March 29, 2008
Home buyers sometimes get into trouble because they don't understand the steps involved in financing their purchases. These steps are qualification, preapproval, approval and lock.
Qualification (or pre-qualification, as it is sometimes called) is an opinion that your income, assets and current debts qualify you for a loan of some specified amount. The opinion may come from a lender or a real estate agent, or it may be your own, based on your use of an affordability calculator. Whatever the source, the opinion does not take your credit into account, and no one is committed by it.
Real estate agents once did a lot of qualifications, often back-of-the-envelope affairs, so that they would not waste time looking for houses in a price range the buyer could not afford. Increasingly, they ask borrowers to be preapproved by a lender first, because it is more reliable than a qualification, and lenders are willing to provide it free as a way of stimulating business. Home sellers have also learned to ask potential buyers for a preapproval.
Preapproval is a conditional commitment by a lender to make a loan before the identification of a specific property. On a preapproval, unlike a qualification, the lender verifies the information you provide and checks your credit. A preapproval will stipulate a loan amount or monthly payment, but not necessarily the loan type or price.
The lender's commitment under a preapproval is always conditional, but rarely are the conditions spelled out. Preapprovals don't have expiration dates, but considerable time may elapse before the borrower returns to convert the preapproval into an approval. During that period, things can happen that cause the lender to back off. For example, the borrower's credit deteriorates or she loses her job. No one can reasonably expect a lender to approve a loan in those circumstances.
Less clear-cut are the effects of adverse market changes, such as the tightening of underwriting requirements that occurred last year, on outstanding preapprovals. If a lender has preapproved a loan and the market changes to the point where the same loan would not now be approvable, would the lender honor its obligation? I fear that in most if not all cases, the answer is no. Fortunately, such abrupt changes in underwriting rules occur infrequently.
Approval is a commitment by a lender to make a loan. Unlike a preapproval, a specific property (along with its appraised value) is identified, and the loan details are spelled out. These include the type and purpose of the loan, down payment, and type of documentation. It will also include an interest rate, even though a rate is not firmly established until it is locked. The presumption underlying an approval is that the probability of closure is high -- much higher than with a preapproval.
It is not 100 percent, however, because borrowers sometimes drop out, and sometimes conditions that accompany the approval are not met. Approval letters contain "prior to doc" and "prior to funding" conditions, which are checklists of nitty-gritty details that must be completed before the final documents are drawn, and before funds are disbursed. Sometimes, one of these details derails the train.
Lock is a commitment by the lender to a specified price -- rate and points. Ordinarily, lenders lock at the borrower's request and view the borrower as being committed as well, though they don't always communicate this very well or at all. Because locking imposes a cost on lenders, some of them charge a nonrefundable fee, which may be credited back to the borrower at closing.
Prospective home buyers should qualify themselves: They are much better positioned to know what they can afford than anyone else. (Calculator 5a on my Web site, http://www.mtgprofessor.com, can help with these calculations.)
Borrowers should get preapproved as a way of establishing their bona fides to home sellers and real estate agents. Only one preapproval is needed, and it does not commit a borrower to the issuing lender. It is only fair, however, to include that lender among the loan providers you shop when you have a contract to purchase and need a loan.
When your loan is approved, lock the price the same day, because that is when you know the price. Holding off because you expect market interest rates to decline is a bad gamble. You don't know how to forecast future interest rates any more than I do. Besides, unless you can monitor your rate on the lender's Web site, the market rate when you finally lock will be what the lender says it is.
Jack Guttentag is professor of finance emeritus at the Wharton School of the University of Pennsylvania. He can be contacted through his Web site,http://www.mtgprofessor.com.
¿ 2008 Jack Guttentag
Distributed by Inman News Features