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Why Pre-Approval Letters are Just Paper Promises

By Jennifer Shapiro on Feb 1, 2021

Posted in Blog
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Why Offers with a Pre-Approval Letter are Less Competitive than Ever

There are two main reasons that mortgage offers with pre-approval letters are struggling more than ever to compete in today’s market: the conditions of the current seller’s market, and issues with the traditional mortgage process.

Pre-Approval Letters are Being Beaten by Cash

Let’s Start with the Market Conditions

Never have sellers had the ability to be as picky as they are in 2021. In 2020, real estate took a dramatic turn in terms of how homes are bought and sold. The housing market was already struggling with a noticeable lack of supply. Then came the pandemic, which fueled a desire for homeownership that we haven't seen in a long time...arguably, ever. Much of the workforce began working remotely, and the word “home” took on new meaning for homebuyers as a 24/7 destination and haven. Buyers from all over the country migrated in droves to neighborhoods in the suburbs, even if it meant having to relocate out-of-state. This trend is showing no sign of slowing in 2021. Locations that weren’t previously considered a possibility for many Americans have now become a pressing reality for health, financial, and other reasons.

This increase in housing demand skyrocketed as supply continued to dwindle, and mortgage rates fell to historical lows. This trifecta of factors has created a record seller’s market with no end in sight. A balanced market is usually marked by four months of inventory. This means that at the current level of demand, if new homes stopped being listed, the supply would last approximately four months. Right now, many markets nationwide barely have three weeks of inventory, which means they are dangerously close to running out listings.

Given these market conditions, standard homebuyers, who typically rely on a pre-approval letter and a mortgage offer to secure a home, are increasingly being left on the sidelines waiting the game out.

Now, About the Traditional Mortgage Process...

When the mortgage box is checked on a real estate offer, the seller and listing agent immediately think: ok…the buyer is saying a bank will probably loan them the money…. so what? show me the money!

This is because the traditional mortgage process relies on a pre-approval letter, which is simply a paper promise based off a relatively quick interview. This interview involves asking the buyer about income, debts, etc., and combined with a credit check, gives the loan officer what he or she needs to calculate debt-to income ratio. If everything lines up, then…. Voila! The borrower now has a pre-approval letter based entirely on his or her word.

Notice that in this pre-approval process, nothing was done to actually verify income with hard documents. This doesn’t happen until 30 or more days after the home goes under contract, during underwriting, often the same week as the home is set to close. By this time, the home has been under contract for weeks or months, and the seller has most likely stopped marketing and showing the property. All it takes is an underwriter spotting a single red flag a few days before the closing to cause the whole deal to fall apart.

According to the National Association of Realtors, mortgage contingencies have a 21% fallout rate (the rate at which deals fall through after going under contract). In a competitive seller’s market, this risk for the seller is why an offer with a mortgage contingency may never make it to the pile of offers being considered.

If the buyer’s loan does not come together in time, it is back to square one for the seller and listing agent. They will have to re-list their home, causing other agents and buyers to wonder what happened. Prospective buyers may assume there was a problem with the home, never knowing the real issue was the previous buyer’s financing. Often, sellers have to reduce the list price as a result.

For buyers, it can be heartbreaking to invest so much time in a home search, and pay for all the due diligence only to find out: they were never really qualified to get financing in the first place.

In Summary...

With all the contingencies associated with a mortgage offer (and we didn’t even get to appraisals), it is easy to see why it is the most unattractive checked box on a real estate offer. That’s why companies like Accept.inc are seeing such success and rapid growth by turning mortgage offers into all-cash offers. Thus, levelling the playing field to give buyers that qualify for a mortgage an equal chance at winning with a cash offer.

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