Getting a preapproval credit letter is kind of like getting a college acceptance letter or a job offer letter. It feels great that someone likes and trusts you enough to welcome you into their community. Receiving a preapproval credit letter is also very satisfying since it often takes 2 – 5 weeks to get through the preapproval process.
But just like college or work, the hard part begins once you have accepted the terms. After getting preapproved, you've got to find a house, put in an offer, get the offer accepted, go through all contingencies, sign all the papers, and actually be OK with assuming a mortgage.
Let me share what a preapproval letter looks like after writing about how to get preapproved in the first place. Then I'll share what comes next. Getting a preapproval letter is a must in a hot real estate market.
What A Preapproval Letter Looks Like
After three weeks of providing endless documentation to the lender that refinanced my previous mortgage, I finally got an encrypted e-mail from them with the following preapproval credit letter.
The preapproval mortgage amount is $1,700,000 with a target purchase price of $2,800,000. The down payment amount is $1,100,000, creating a Loan-To-Value ratio of 60.71% ($1.1M / $2.8M). The loan type is a 7/1 ARM, my favorite type of mortgage, with an incredibly low 2.125%.
There was a time when I would only take out a 5/1 ARM because the 5/1 ARM offered the lowest interest rate with the most comfortable period of fixed rate duration.
However, in recent years, the 7/1 ARM has become even more attractive. This is due to the way the yield curve has flattened or inverted. Not only do you get two more years of a fixed rate, but you also get to pay a lower mortgage rate when compared to a 5/1 ARM or a 30-year fixed-rate mortgage.
The monthly payment on a $1,700,000 mortgage at 2.125% is low at $6,390.33. To give you some perspective, when I bought my first single-family home in 2005 for $1,525,000, I took out a $1,225,000 5/1 ARM mortgage at 4.75%. My monthly mortgage payment was also $6,390. It's nuts how, more than 15 years later, I can borrow $500,000 more for the same amount due to a decline in mortgage rates.
Greater Wealth Is Fueling Demand
During this 15+-year time period, most of us have seen our income and/or or net worth increase tremendously. Therefore, the combination of greater wealth, greater home equity, and lower mortgage rates are significant factors in propping up the real estate market during these uncertain times.
Please note that the 2.125% mortgage rate is helped by relationship pricing. I have assets at the lender that qualify me for their highest discount rate. But even if you can't get 2.125%, you can probably still get 2.5%-2.625% on a 7/1 ARM jumbo loan, which is dirt cheap.
You just have to check online and have qualified lenders compete for your business.
What To Consider Before Applying To Get Preapproved
Mortgage Amount Or Price Of Home
You might be wondering whether you should apply for preapproval based on a specific mortgage amount or whether you should apply based on the price of the home you want to buy. You can go either way because eventually, both paths will lead to the same destination. In other words, the bank will ultimately decide how much you can get preapproved for.
In general, people tend to search for homes they want to buy based on a price range. The price range is determined based on one's income and down payment. From there, a prospective homebuyer will provide the mortgage officer with the pertinent information to get the process going.
In my situation, a home popped up online that I thought looked amazing. The asking price was $2.9 million, which I thought was a little overpriced. I wasn't comfortable paying more than $2.8 million, which is why I gave $2.8 million as the target sales price to my lender.
It was a gamble since there was no guarantee the seller would sell for $100,000 below their asking price. If the seller didn't budge and I really wanted the property, I would have had to come up with a $1.2 million down payment instead of a $1.1 million down payment. But I had to go with a price that worked best for me. This is what all of you should do as well. If I lost the property, so be it. There's will always be another great property for sale.
More Credit Is Better Than Less
Now that I have the preapproval letter, I realize that I should have applied for an even larger preapproval credit amount, especially now that credit is becoming more difficult to secure. The reason why is because it's much easier to borrow less than what you are preapproved for, rather than borrow more.
Right now, I'm limited to buying a property that's valued at $1,700,000 (preapproved mortgage amount) + however much I can put down. If I wanted to take advantage of higher-end luxury property that may show more weakness, I can't because I lack the funds.
Having to go through a new amended preapproval process to obtain more credit will take another 2-5 weeks of time.
What The Preapproval Letter Means
The credit preapproval letter means:
- The buyer has filled out a mortgage application
- The bank has checked out the buyer's credit and the credit has been fully approved
- The buyer has provided financial information and documentation such as W-2s, pay stubs, and bank statements.
- An underwriter has reviewed all your information and made an initial decision on your application
- The buyer has received the highest standard of credit approval to help him or her shop for a home
As a seller, unless you are desperate, you should only deal with potential buyers who are preapproved. Otherwise, there is a much higher chance the deal will be delayed or fall through due to financing contingencies.
When I was trying to sell my single-family rental in 2017, the buyer breached the financing contingency deadline by two weeks because his lender had some issues with his job transfer. It was a very stressful process since he was my one and only buyer.
During times of uncertainty, lenders tighten their lending standards to protect their businesses. For example, Wells Fargo and Chase have announced they are only accepting homebuying applicants who have 20%+ down and a 700+ credit score. Many potential buyers who are only prequalified may be very disappointed when it's time to actually get funding.
Preapproval Letter Disclaimer
Here's a disclaimer that also came along with my preapproval credit letter that you may also get: This credit approval is based on a mortgage product and terms currently available. A credit approval is not a commitment
to lend, and it is subject to change or termination if: the loan no longer meets applicable regulatory requirements; and/or there are material changes resulting from the receipt of updated information that would cause your loan application to no longer meet our underwriting requirements; and/or there are changes to mortgage requirements beyond our control, such as those imposed by investors, government agencies, or mortgage insurers.
In other words, despite getting preapproved, the borrower will still have to be in good standing. The borrower will have to provide all the pertinent follow-up documentation requested.
How Long Does The Preapproval Credit Letter Last?
Despite spending 2-5 weeks on average gathering documents, explaining financial transactions, gathering even more documents, and waiting, your preapproval letter only lasts a finite amount of time.
On average, you've got between 30-45 days to use it until your preapproval letter expires. After 30-45 days your lender will start requesting the last two months of financial documentation to reprove your creditworthiness.
If your income and financial situation haven't change, you should have no problems getting preapproved again. It will just take time to gather up and send the latest documentation. During the 30-45 days be careful not to do anything drastic with your occupation or your finances.
Changing jobs, quitting your job, buying a car with debt, going to Vegas to bet all your money on black, and forgetting to pay your credit card bill are some red flags that will jeopardize your preapproval process.
Next Steps After You Get Your Preapproval Letter
Once you get your preapproval letter, package your preapproval letter with your real estate love letter when making an offer. Making an extra effort could make a difference since many buyers do not.
One thing you may be curious about is whether you can lower the estimated sales price in the preapproval letter. Sometimes you may want to make a lower offer after getting into contract. For example, I didn't want the seller to see a $2,800,000 estimated sales price in my preapproval letter if I was only going to offer $2,700,000. Unfortunately, my lender said they could not alter the estimated sales price in the letter. It would require going back through underwriting again.
When you’ve found a home and your offer has been accepted, you will then have to:
- Obtain an acceptable appraisal and title commitment
- Go through a final review of all information and documentation with your lender
- Provide new documentation, such as proof of the 3% earnest money down payment
Like I said at the beginning of this article, the real work begins once you've received your preapproval credit letter. Hopefully, you will have gotten preapproved well before you've found your ideal property.
When it comes to buying property, please take your time. You've only got a limited amount of credit. Make the most of it!
Recommendations: Refinance And Invest More Surgically
If you're looking to refinance a mortgage or buy a new property with a mortgage, check out Credible. Credible is a leading lending marketplace where lenders compete for your business. Get free real quotes in minutes. Mortgage rates are at all-time lows. Take advantage!
Also take a look at real estate investment opportunities given record-low mortgage rates. Fundrise and CrowdStreet are my favorite real estate marketplaces that allow you to invest in real estate across the country.
Fundrise focuses on private eREITs that provide investors with steady and diversified real estate exposure. CrowdStreet focuses on individual commercial real estate deals in 18-hour cities. Valuations are cheaper and rental yields are faster in 18-hour cities.
Both platforms are free to sign up.
With the work-from-home trend booming due to lockdowns, real estate in lower cost areas of the country with lower valuations, higher net rental yields, and lower density will likely do well due to a large migration shift.