Despite a heightened, post-recessionary industry awareness, the number of poor pre-approvals in circulation surprises me. A sure indication of that must be the number of listing agents calling at the time of receiving an offer to confirm the validity of pre-qualification.
Poor pre-approvals exist for a variety of reasons, including the obvious ones such as last-minute requests, overconfidence, sloppy process, disorganized (or sometimes dishonest) buyers, lack of proper corporate culture, or even the lack of knowledge and experience. All of them result in a superficial analysis that misses on easy to overlook, but often-critical details that can potentially jeopardize the transaction.
Here is a real-life example of how a pre-qualification analysis could go wrong. I have a customer who earns over 160K per year on W2 with no major liabilities or derogatory on his credit. In other words, he is a perfect borrower to many originators, who would not hesitate to issue an instant pre-approval. My customer has a problem however, buried deep inside his financials. His pay structure changed from 100K base salary + 60K commissions in 2012 to a miniscule base salary and 160K commissions in 2013. On the surface, not much has changed since both pay methods produce a W2 reporting 160K income. To the underwriter, however, the results is a 50K income drop! Why? Because, the base salary is now close to $0, while income derived from commissions is only 110K per year (income from commissions is an average of the last two years (60K+160K)/2 = 110K). And this is a best-case scenario, because to a conservative underwriter, a sudden tripling of commissions earnings could be perceived as one-off event without any guarantee for future sustainability, and thus disregarded from income calculations altogether.
In this particular case, when I realized that the financials were not adding up upon my initial examination, I ordered a full verification of employment with salary details as part of my pre-qualification process. In addition, prior to issuing the pre-approval, I have also secured an exception with my underwriting manager to ensure that the increase in commission earnings will be honored. Had I not done all that, there is a very high probability that my pre-approval would put the buyer in a position of trying to purchase a property well outside of his price range, thus leading to transaction failure.
To me, thorough pre-approvals are essential part of the service – the better the pre-approval the less work is required at the time of loan submission. In fact, most of my pre-approvals are near-complete loan packages.
Take away #1: Always insist on lender issuing a pre-approval based on a complete set of financial documents and thorough analysis of thereof. Never agree to show any properties to buyers who did not disclose all requested documents for their pre-qualification.
In Deadly Mistakes of Real Estate, Part 2: DOs and DON’Ts of Property Buying
If you have an interesting story or a piece of advice you wish to share I would love to hear it – call me or write to me and your idea could become the topic of my next article.