Getting pre-approval for a mortgage. What is in it for the buyer and the seller?

Let’s talk mortgages! Getting pre-approved for a mortgage should be the first step in your home buying process. It is important for several reasons.

Following is a short overview about mortgage pre-approvals for both buyers and sellers.

A mortgage pre-approval; what is in it for the buyer?

• A mortgage payment is usually the biggest expense in a monthly budget. It is important to know what you can borrow, so you can understand your responsibilities on a monthly basis and act accordingly. Many people have a comfort zone when it comes to financials. Know your comfort level, and buy within it for peace of mind.
• A seller has the right to ask a buyer for proof of the pre-approval in the form of a letter. It gives a seller much more confidence to take a buyer seriously. If the buyer is not pre-approved, the seller may pursue negotiations with a subsequent buyer who is pre-approved.
• You get a rate hold. Pre-approval letters are usually valid for 90 to 120 days. If the interest goes up in the meantime, the bank is committed to the rate in your commitment letter.
• Knowing what you can and are willing to afford gives you a stronger position in negotiations.
• You don’t waste time looking at homes that you can’t afford. While looking at homes you can’t afford, you may miss out on a home within your budget.

Sometimes it is a seller’s market; sometimes a buyer’s market. With a clear pre-approval letter, you can take advantage of both types of markets. In a seller’s market, a pre-approved buyer wins the trust of the seller. Especially if there are more buyers putting in offers on the same home. In a buyer’s market, you acknowledge your line drawn in the sand, and you can walk away having a stronger position in the negotiations.

• If you are not pre-approved, you may lose the home. It takes time to get approved for a mortgage, and a buyer must submit many documents such as pay stubs, proof of funds, a letter of employment etc. Most offers to purchase include conditions such as financing. In Calgary, buyers are usually allowed 7 to 10 business days to fulfill these conditions. The issue of delay can be with the lender, but just as often with the buyer. Sometimes, buyers are scrambling for the right paperwork, delaying the approval and missing the deadline of the condition date.
• Nothing is more frustrating than finding the home you love, going through the stress of writing an offer and negotiating, and finding out a week later that you didn’t get the financing. You don’t want to fall in love with a home that you cannot afford. Being pre-approved simply prevents frustration and stress and disappointment.
• Realtors don’t like to work with buyers who are not pre-approved. This makes sense because a realtor spends time and money on showings and doesn’t get paid until the transaction closes. A transaction falling through on financing is frustrating for buyer, seller and realtor.

A mortgage pre-approval; what is in it for the seller?

• A seller has the right to ask for proof that the buyer can afford the house
  As previously mentioned, a seller has the right to ask for proof that the buyer can afford the house. This way, a seller minimizes the risk of wasting time and losing a potential sale, and, potentially, money. This proof only needs to state that the buyer has been approved and is able to purchase a particular house. It does not state how much a buyer is approved for because that is still confidential.
• At times, the real estate market strongly favours sellers, and multiple offers on a property are a good possibility. A seller can ask for proof and choose the right buyer with more confidence. It is a fact that if a sale falls through on financing, a seller loses more than just that one buyer. He loses other potential buyers, and also time and momentum for a higher sale price close to the date of listing.

What is in a mortgage pre-approval letter?

A bank or a mortgage lender gives a letter of pre-approval, also called a commitment letter. This letter confirms:

• the principal amount a buyer can borrow,
• the interest rate to pay, the expiration date of that interest rate,
• the term and amortization time,
• the conditions for the approval. These are often standard conditions, such as confirmation of credit score, confirmation of down payment and so forth.

Also, the rate hold, as mentioned earlier, is clear in this pre-approval letter. A pre-approval is valid for 90 to 120 days. If, in the meantime, the interest rate goes up, the lender is committed to grant the lower interest rate, stated in the pre-approval letter.

A pre-approval is still no guarantee

It is important to understand that a pre-approval is still not a 100% guarantee that the mortgage will be issued. Next in the process of a pre-approval is the evaluation by the underwriter. Once a conditional sale is in place, the underwriter looks at the entire file of the buyer. All buyer’s documents are scrutinized again, as well as the property to purchase. Sometimes properties are flagged in the lender’s system. For example, the house may have been a grow op many years ago. Also, many lenders request an appraisal of the property. This appraisal is merely to confirm that the lender is not ‘overpaying’ on their collateral.  The lender may decline to issue a mortgage if the appraisal turns out to be lower than the purchase price.

Also, if the buyer does not have a down payment of 20%, the mortgage needs insurance. An insurance company, like CMHC, may decline the request to insure the mortgage. Unfortunately, these insurance companies don’t pre-approve buyers like banks do. Hence, a buyer with 20% down gives any seller much more confidence.

The cost for buyer and seller if the buyer is not pre-approved for a mortgage

In general, the process of pre-approval goes smoothly. However, over time, we came across scenarios that negatively impacted buyer and seller. Here is just one good example of what extra it can cost the seller to sell to a buyer who appeared unapproved.

An ‘approved’ buyer wrote an offer to purchase on a condo. After a long day of negotiations, the buyer and seller came to a conditional sale. The buyer negotiated the conditions of a home inspection and a condominium document review. The buyer was pre-approved, but only verbally, and immediately submitted all the paperwork to the lender. In the meantime, the buyer needed to fulfill both conditions of the home inspection and condominium document review. Both these services cost money, about $900 in total. After 9 business days, the lender rejected the mortgage approval. For the pre-approval, the buyer had submitted most information verbally. However, the documents actually  submitted showed different information. The buyer could not waive the financing condition and lost valuable time, as well as hundreds of dollars, to the home inspector and the condo document review.

During the condition days, the property was off the market because it couldn’t be sold twice. In the meantime, for the seller the momentum of sale was lost. Much more damage was done because the seller lost other interested buyers hoping to purchase the property. Statistically, a home sells for a higher price in the earliest stages of listing. The condo was on the market longer, statistically going for a lower sale price.

In this particular case, the condo was priced at $175,000. The first offer was full list price, the second offer only $170,000. The seller lost $5,000 due to an un-approved buyer.

Don’t ruin your credit score before taking possession!

After buying a home, there is usually a waiting period of 2 to 12 weeks before the buyer takes possession of the home. It is important to know that a buyer needs to be conscientious with credit card spending during this time. Shortly before the mortgage funds are transferred, the lender examines the entire file of the home purchase again. If the buyer used the credit card on a ‘shopping spree’, it could harm the credit score.  As a result, the mortgage can be declined at the eleventh hour. This means that the buyer still loses the home and also the deposit. On top of this, the seller can sue the buyer if the seller lost money in the process of selling the home again.

We witnessed a scenario like this with a buyer. Between buying and possession, the buyer twice forgot to pay off a credit card. Right before releasing the funds, the lender checked the file again. The buyer’s file got flagged on credit issues, and, as a result, the lender did not issue the mortgage. The buyer had to scramble for a solution so as not to lose the house and his deposit. A family member, in this case a brother, was both willing and able to help out and became part of the purchase. The deal was saved, but the joy of receiving keys to a new home was slightly diminished in the process.

Similarly, we also learned about home buyers maxing out their credit cards to purchase new items for the new home, like new curtains, new furniture, etc. This significantly changed the credit situation of the buyers. As a result, and literally at the last hour, the mortgage provider refused to lend the money. Also in this case, a family member, the father, saved the home and deposit by assuming part of the purchase.

Don’t alter the purpose of the home

Another issue we ran into was a buyer who changed his information on the use of the home. Initially, the agreement between lender and buyer was that the buyer would live in the house, not rent it out. In talks with the lawyer, this buyer indicated that he planned to rent it out. The lawyer informed the lender about this change. Investment properties have different mortgage rules. Rentals usually require a higher down payment; 20%

As a result, this buyer’s file was flagged one day before possession. The lender refused to issue the mortgage. In this case, the buyer did not have family to rely on. He needed to find a new lender to get qualified again. Possession was uncertain, yet did go through, but 8 days later. The buyer now owed late payment fees to the seller, and both buyer and seller experienced enormous stress.

What else can hamper a pre-approved mortgage?

Besides ruining a credit score or falling behind on credit card payments, several other things can hinder a mortgage approval at the last hour. Opening new credit cards can halt a lender from issuing a mortgage, as well. Quitting jobs or changing jobs is another important factor. Most lenders require buyers to be with the same employer for at least 3 months. Sometimes buyers get a substantial financial gift from parents to help with a purchase. A gift letter is deemed part of the proof of this gift. If the lender finds out that the gift letter, or any other assumed proof, is falsified, the mortgage approval will be cancelled.

 

What is the difference between a bank and a broker?

A bank can only offer their own products. A mortgage broker has many lenders in its portfolio and ‘shops around’ for the right mortgage. Quite often, we see that the interest rate offered by a mortgage broker is slightly more competitive than a bank offering. Also, buyers who are more specific, such as newcomers or those who are self-employed, often have a better chance with a mortgage broker. A broker can submit a mortgage request to different lenders, and some lenders accept ‘higher risk’ buyers.

If it comes to availability and responsiveness, the mortgage broker surpasses the bank. The mortgage broker is self-employed, and the banker is employed, which presents a different motivation. Banks have, though, certainly improved their services over the last few years. Many banks now employ so-called ‘mobile mortgage specialists’. These specialists are more often available outside of business hours, as well. However, several times we witnessed a buyer almost losing a house because the bank employee had already left work when the financing condition was due. In one case, the mortgage broker stepped in at the last minute, and the buyer was able to waive the financing condition minutes before the deadline.

Also, the mortgage broker wins when it gets to the timing of getting pre-approved. In our experience, mortgage brokers are faster with pre-approvals. On numerous occasions, the bank took weeks to get a client pre-approved, and the buyer lost valuable time because of it.

 Online mortgage pre-approvals are not good

Lastly, many websites offer an online pre-approval for a mortgage. These type of approvals are not secure. An online pre-approval is too limited and can’t be trusted as a reliable pre-approval. The entire mortgage approval requires human input to qualify. Over the years, mortgage providers have gotten a lot more finicky. They often ask buyers for additional information, more proof etc. To avoid any stress, it is always prudent to contact bank and broker as early as possible.

We are Tanja van de Kamp and Ariette van Pelt, working as a team, both buying and selling homes in Calgary. Calgary has been our home since 2004, and real estate our full-time profession since 2009. Tanja was a lawyer in The Netherlands for 12 years, and learned how to negotiate strategically, and to work in the best interests of her clients. Thanks to our honest and transparent approach to real estate and towards our clients, we have built our business. It’s been a privilege to work with our clients, and, over the years, many clients reciprocated their appreciation of us, as shown through their many referrals.

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Please note: The above is general information and not considered legal advice. We do our best to write informative articles about real estate in Calgary, Alberta. If you have any questions or concerns about our comments, please feel free to contact us or speak to your legal advisor.