One of the most common documents submitted along with a contract offer to purchase real estate in Chicagoland is the pre-approval letter. How important is this letter? It is not important at all. You read that right. It is not important. Want to know why?
To understand why the pre-approval letter is unimportant, you really need to understand a bit about the mortgage lending process and the home buying process. Typically, a potential buyer looking to get into the market will talk to a lender before they start their home search. They will tell the lender, usually during quick phonecall or a short meeting, a little bit about their financial condition. They will talk about things like how much money they make on their job, how much debt they have, and their investments and savings. After gathering this information, a mortgage broker or Lender will issue a pre-approval letter.
However, you have to understand what a pre-approval letter really says. Essentially, the letter indicates that if everything that the prospective borrower told the mortgage lender is true and if the property appraises and if there are no problems and if the credit score is good and if the ratios work and if the loan can make it through the lender’s underwriting scrutiny, then yes, the lender will make a loan… probably. That is a lot of “ifs”. Worse yet, because most folks getting ready to buy in Chicago are not lending professionals and don’t do this kind of thing every day, most prospective buyer don’t really know the important things to tell their lender upfront that might be roadblocks to getting a loan! Adding to this problem is the fact that the mortgage lenders and brokers are paid when a deals close. As a result, most lenders and mortgage brokers have little incentive to send a potential borrower away. That’s a potential client! Instead, they issue a pre-approval letter and the chips fall where they may.
Because some mortgage lenders and brokers are afraid to lose potential business, they will give a pre-approval letter to just about anyone. Now, to be fair, do some lenders do an amazing job of doing due diligence and give wonderful counseling to their borrowers to get them on the right track? Yes, they do. The trouble is, you, as a seller can’t tell a good pre-approval letter from a bad one. A typical buyer could probably obtain 10 pre-approval letters with 10 simple phone calls.
What a pre-approval letter really means is that a potential buyer has contacted a mortgage lender to do initial due diligence and that the lender has done the same and there are no open or obvious issues standing in the way of getting a loan. Is that any sort of guarantee that the borrower will get the loan? No. Not at all. Should a seller rely on a pre-approval letter as meaning anything more than that their buyer is reasonably engaged in the home buying process? No.
A pre-approval letter does not take into account the appraised value of the property, the financial condition of a condominium association, any variations in Chicagoland market interest-rates, buyer credit scores, or other information not readily available through that initial simple chat or meeting with a prospective buyer. The preapproval letter leaves much to be desired.
Too often, sellers are baffled when a buyer in their sale transaction asks to extend a mortgage contingency because the buyer doesn’t yet have their loan. They say things like “but I thought they were pre-approved”. That seller has no understanding of the truth about a pre-approval letter.
It is worth noting that until a loan is approved, it is not approved. One of the very tragic misunderstandings about loan approvals comes from the lending industry itself. They love to use the word “approved”! They just can’t help themselves.
What does pre-approval mean? It means no approved.
What does approved with conditions mean? It means not approved.
What does approved subject to a satisfactory appraisal mean? It means not approved.
What does approved subject to add closing conditions mean? It means not approved.
It is probably fair to say that until a loan funds, it is not approved. To think otherwise would be foolish and could lead to unreasonable reliance on the lender. That’s why we need things like mortgage contingencies for buyers and home sale contingencies for sellers who are looking to buy their next place.
That is not to say that a typical seller should not expect to see a pre-approval letter from a local and reputable Chicagoland lender submitted with an offer. However, it is not worth putting all that much stock into.