Mortgage Preapproval Explained

May 13, 2008 9:26 AM Pacific Time

Mortgage Preapproval Explained

Definition
Mortgage preapproval involves the application and approval for a mortgage prior to selecting a home for purchase. A preapproval may also be used in conjunction with a refinance transaction, but for this explanation, the focus will be on home purchases.

A preapproval is not a binding commitment on either the applicant or lender, but rather an indication that the lender is ready, willing, and able to extend a mortgage to a mortgage applicant once a suitable property has been secured via a real estate contract.

How it Works
A prospective homebuyer fills out a residential mortgage application with a target loan amount and sales price. These amounts may change as a buyer wades into the property market, but it's important to establish a starting point. The mortgage lender subsequently reviews the application, credit history of the applicant(s), and depending on the type of mortgage request may verify the applicant's income and down payment sources. This process typically takes 7-14 days.

Why it is Beneficial
A mortgage preapproval removes one of the uncertainties in buying a home. A buyer can make an offer with confidence, knowing he/she will not fail to secure a home due to a mortgage underwriting decision. Sellers also enjoy the comfort of knowing the buyer is sincere in his/her home ownership goal.

Why They Are Not Guaranteed
A mortgage preapproval is based on the mortgage applicant's credit, as well as income and assets (in some cases). While the lender is expressing a desire to fund a mortgage based on the applicant(s) credit and income, issues relating to the subject property might cause the lender to decline to participate in a mortgage. Examples of this include but are not limited to: a purchase price not supported by a market appraisal, homes with structural damage, homes with open building permits, or a home having a feature which may limit the marketability of the property - such as biological, chemical, or environmental hazards.

Another potential hurdle regarding mortgage preapprovals is a fluctuation in interest rates, and/or the buyer's financial picture since the time of initial mortgage approval decision. If interest rates move up sharply, or the buyer's income or downpayment suffer an unexpected decline, the basis for the mortgage preapproval will have changed and therefore the lender may choose to decline to participate in a mortgage.

Does a Preapproval Mean There's No Need for a Financing Contingency?
No. The financing contingency in most real estate contracts is a form of buyer protection, in that it allows the buyer to exit the contract if a lender is not willing to participate in a mortgage. Although a mortgage preapproval indicates a lender has expressed a willingness to make a loan based on the applicant's credit and income, the preapproval does not imply the lender will automatically accept the subject property.

How Long Do They Last
A mortgage preapproval is generally good for 60-90 days, after which the lender may require an update to the credit report and/or other exhibits within your application file. Further, although the lender has issued a credit decision in advance, nearly always it will reconfirm the data which led to the initial decision. If any part of your financial picture changes - be it credit, income, or asset related - it is critical to alert the lender of these changes so that your preapproval can be reissued and/or adjusted.

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