The Death of the Pre-Approval?

Rather proud. (Photo credit: This Year's Love)

It's pretty standard in the real estate industry for Realtors to require their clients to get a mortgage pre-approval before spending any time showing them properties.  It saves both parties time but what many buyers don't realize is the pre-approval you get now is not the same as it used to be.

During the boom years when the banks were swimming in money it wasn't a problem to cover the costs of pre-approvals but things have changed.  There are two significant costs involved for a financial institution to offer pre-approvals.  The first is the cost of underwriting; the underwriting staff can spend more time looking at pre-approvals that never fund than they do on live deals.  In most businesses staffing is the largest cost of business so more than doubling their workload can be expensive.  As a result, most pre-approvals are no longer underwritten.  They are generated by a computer which checks the basic facts such as beacon score and debt ratios to ensure the application fits within a lending program.

The second cost is hedging the rate hold.  All lenders hedge their rate holds because they have no idea where the rates will be when and if the deal funds so they short the bond market so that if rates go up they can still afford to offer the lower rate.  They have to perform this process for pre-approvals and live deals alike.  With a live deal they know exactly how much and when they need to invest for but with pre-approvals it's and expensive guessing game which may not even fund (60% don't) and mortgage professionals tend to enter the maximum mortgage that a particular client can afford which is likely more than they'll end up spending.  The result of this cost is a markup in rate of 0.20% by most lenders and the cancellation of pre-approval programs at others.

So what used to be a reasonable estimate of whether or not a client would be approved for financing has now become just a bad rate hold.  That being said, it's still a good idea to get pre-qaulified by a mortgage agent to avoid potential problems.  The job of underwriting has fallen to the broker.

If the current trend continues (and there's no indication it won't) I foresee a time in the near future when most lenders won't offer pre-approvals and the one's that do won't be any more than a rate hold that will only protect homebuyer's from drastic rate hikes.

Related articles

• Simple Definitions: Pre-Qualfication and Pre-Approval
• Pre-Approval Do's & Don'ts