A mortgage preapproval is a written commitment lenders give to buyers that states the maximum size home loan they can get as well as the likely interest rate. Buyers rely on preapprovals to make sure they’re shopping for a home that’s in their price range. But new federal data suggests lenders are scaling back on preapprovals. Among the top 25 mortgage lenders, just 29,912 preapprovals resulted in mortgages that borrowers received to purchase a home last year, according to data released last month by the Federal Financial Institutions Examinations Council. That’s down from 101,626 in 2007, before the housing downturn. Preapprovals accounted for 4% of purchase mortgages that were originated by these lenders last year, down from 9% in 2007.
In addition, preapprovals—which have traditionally been considered one of the first steps to getting a home loan—did not precede any of the mortgages doled out to home buyers by 14 of the largest 25 lenders last year. “The popularity of preapprovals is quite low,” says Mike Lyon, vice president of mortgage operations at Quicken Loans. (The mortgage lender had 598 preapprovals result in mortgages last year, down 43% from 2007, according to this government data.)
The demise of the preapproval comes at a delicate time for home buyers. As competition heats up, bidding wars are becoming the norm; for prospective buyers to stand out to sellers, they often need to show proof that they have lined up financing and are ready to proceed with the transaction, says Jim Gaines, research economist at Texas A&M University’s Real Estate Center. Preapprovals provide that evidence to sellers, and buyers who lack them will have a hard time getting a home that has many offers on it. Preapprovals may also provide some leverage to buyers who are competing against all-cash buyers, who accounted for 32% of existing-home sales in August, up from 27% a year prior, according to the latest data from the National Association of Realtors. Because they don’t need a mortgage, all-cash buyers often make lower offers on homes; a home buyer with a higher offer and a preapproval could beat them out, says Gaines.
To be sure, this government data may not encompass all preapprovals. The numbers are released under the Home Mortgage Disclosure Act, which requires lenders to submit their mortgage and preapproval numbers to the federal government. Some lenders say they don’t submit data for their preapprovals because they don’t meet the federal definition. The official criteria include a written commitment to give a home loan for a certain period of time, with the caveat that approval can change only for a few reasons including a change in the home buyer’s financial standing or some other conditions that could derail a sale, like a report of termites in the home.
Housing experts, however, say the decline in preapprovals is largely due to dwindling competition among mortgage lenders for new clients. Prior to the recession, lenders used preapprovals as way to attract would-be borrowers. Buyers who had this commitment from a lender were more likely to turn to this company when they were ready to get the actual mortgage, says Keith Gumbinger, vice president at mortgage-info site HSH.com. In that way, preapprovals became a revenue source for lenders. Since the recession, many lenders have shut down, and that has decreased competition for buyers, he says.
Separately, lower-than-expected appraisals of homes have resulted in fewer preapprovals, says Gumbinger. Preapprovals are usually given before buyers identify the home they want to buy. When the home’s appraisal is determined to be lower than the purchase price the buyer and seller agreed to, the lender often requires the buyer to come up with the extra cash to make up the difference; buyers who are unable or unwilling to do so walk away, and the preapproval ends up derailed.
Several banks, including Chase and Bank of America, say rather than preapproving home buyers, they’re mostly doing pre-qualifications. With pre-qualifications, lenders inform borrowers of the size of the loan they can qualify for based on their stated income and assets as well as an initial credit check. Historically, pre-qualifications were the first step buyers would take before shopping, which was then followed by a preapproval when they became serious about a specific home they wanted to purchase.
To give buyers a better idea of where they stand, Chase says it provides a more detailed prequalification program through which buyers get a “conditional approval” that usually lasts 90 days, which they can share with the seller. The bank says this type of approval differs from the federal definition of a preapproval because it is not a written commitment; instead, its commitment is often delivered after verifying borrowers’ income, employment and the home’s appraisal. Similarly, a Bank of America spokesman says the bank wouldn’t approve a buyer until the home is appraised and the borrower’s financial condition is fully vetted.
A prequalification doesn’t provide the same leverage to buyers though as an official preapproval. Pre-qualifications are typically based on average mortgage rates rather than the rate that’s close to what the borrower would actually get. Also, most lenders can rescind a prequalification, whereas a preapproval is a commitment that usually lasts two to three months.