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.
Just did a no cost refi on my 30 year fixed from 3.375 to 2.8 through united wholesale mortgage. Their rates are lower than anything I’ve seen advertised on bankrate, etc. Just throwing it out there in case anyone else can benefit…
I also just refinanced with UWM and got a 2.99% on a 30 year fixed. Highly recommend everyone refinancing to take a look.
Sam, your series of posts around your latest SF Home purchase was one of the best and most informative things I’ve ever read. I actually found myself refreshing your website multiple times per day to see if there was an update. I hope you can do something similar this time round or provide an update on what you ended up doing with your other Real Estate Investments. Did you end up renting your place out or converting to a home office? Will this new 2.8M home be for investment purposes or another upgrade for your family to live in?
Glad you’ve enjoyed them.
Yes, I ended up renting out my old place and converting the downstairs to a home office. I have another series of posts on that subject. Was going to publish, but the coronavirus pandemic and the shifting landscape got me!
Lesson learned: always publish ASAP.
Not sure about this new $2.8M home…. hard to find bargains. May just buy in Hawaii.
We’re looking to refi in the Bay Area (Los Gatos Mountains). House is appraised at $1.24M+ Principal balance is ~$956K. We’re on a 10/1 ARM @ 3.75%. Our lender(Chase) is telling us our best option is a 7/1 ARM at 3.375% APR. Which would bring our monthly payment down by around $250.
Seems like we can do better than this according to your refi? We have zero debt and around $400K combined yearly income with excellent credit. Do we just go bank to bank? Credit union? Seems like we’re going to have to invest a lot of time into just seeking out a better rate, but definitely worth it if we can save $. Any idea what rates we should be shooting for?
I would first get some competitive quotes online. Check out Credible and maybe LendingTree. LendingTree is pretty aggressive though, so expect some calls. But aggressive is what you want in terms of a low mortgage rate.
Then I would use the quotes to pressure your existing bank, Chase, to match or come down if they are higher.
You can also consider transferring assets, like I did, to get a better rate. I transferred $1M to the bank who gave me the preapproval credit letter. It was just a portfolio transfer with cash, so didn’t have to sell. This is called relationship pricing, but it does have some difficulties.
A 7/1 ARM at 3.375% with no fees is at least better than a 3.75% ARM. But yeah, you should be able to do much better, even without relationship pricing e.g. 2.75%.
Hey Sam,
A perfectly timed post as usual!
Curious about your comments on our situation.
We put an all cash offer on some vacant land directly across the street from our primary residence. This was a sudden opportunity that we decided we could not let pass because we want to preserve our privacy and we had the cash set aside for REIT investments or buy opportunities in the stock market.
I’m any event, the offer was accepted and we expect to close in about 30 days (we have a build feasibility contingency in the offer).
Perhaps needless to say, we were not planning to build a new house next door! But we are experienced land lords and entrepreneurs, so we’re studying the idea of a high end vacation rental to make this impetuous act a commercial enterprise (already have the formation documents for the LLC )
So now I’m thinking We should get preapproved to either finance a portion of the land purchase, or for the house itself, or finally, for other possible real estate purchases in the near future (late fall or winter 2021).
My broker agent explained that financing vacant land is difficult on short notice.
Would love your thoughts and/or a feature length post on these ideas.
Wow… that is an impressive financial move to pay cash for the land and keep it empty for a while. Actually, you have to keep it empty as you draw up plans etc.
Maybe a high-end long term vacation rental could be good. But the vacation rental market is crap now due to lockdowns.
You’d have to share more of your finances to give us a better picture.
Privacy is nice though! But having vacation renters is the opposite of privacy.
Good to know! Thanks for all the details. Didn’t realize it takes so long to get a pre-approval letter and then they can expire in 30 days. But it makes sense to put in the effort it you’re serious about purchasing property so that when you find one you want, you can execute fast and hopefully beat out the competition.
Yeah, I’m sure there have been folks who do some crazy stuff with their finances within 30 days of getting their preapproval letter. Banks want to make sure everything is still fine before they lend money, especially during this time.
Who is your lender with relationship pricing? Mine is with Wells with good rates on the 30 year product but not ARMS. Maybe I need a new relationship banker.
Wells Fargo. I did search around, and nobody could beat them due to my relationship pricing.
Don’t be shy. What was the rate on your 7/1 ARM?
Which lender are you using for that low rate? I’m shopping around now and would like a recommendation. Thanks!
Wells Fargo. Definitely shop around online and see what you can get. Just know that my rate is based on having $1 million+ in assets with them.
I used Iberia Bank. They have great rates and do 7/1 arms which I also did with my Jumbo loan.
2.9M for a “home” in San Francisco ? Who can afford this ? If I cannot afford $2.9 million for a home, I don’t think other people should either. It’s not fair. This is what happens to a city when the speculators are allowed to flip properties and borrow money out of control.
No offense please, but if spending this kind of money and signing your good name over to this type of insane mortgage balance is considered “normal” than the the people there are completely delusional.
A massive earthquake, another Covid type virus, or some other cataclysmic event could severely hurt half the population along with the property values leaving millions of people full of debt, destitute and broke.
Hopefully people can feel it in their gut that this is one big house of cards. I suppose the good news is that when an event like this happens at least the poor and homeless will have much better living accommodations to choose from. Hopefully the latte shops will still be open.
I like to focus on the negatives when I can’t get something because it makes me feel better. I’ve been wishing for real estate prices to decline for at least a decade and missed the boat in buying when they did during the last recession. So I’m hoping things will crash so I can gt a deal.
Best of luck to you. I hope you find happiness and what you are looking for in life.
By nature, I’m not a pessimist, so it’s hard for me to understand your viewpoint. But thanks for sharing.
Hopefully more folks can focus on the article’s meaning instead of the absolute dollar figures.
Buying a house in the Bay Area is frustrating. Even after the start of COVID-19 and now during, house prices here have not let up. Sellers pulled inventory from the market and those that remained left prices the same. There are very few to no price decreases unfortunately.
I caved and finally bought a home here after waiting for a price reduction that never happened. I’ve been shopping for a home for the last two years and saw mini corrections on early 4th quarter 2019 just to see it all move quickly back up in 2020. There was some price flattening during the week of shelter-in-place being announced but it was short lived.
I’m not sure if prices will ever go down. I’ve been monitoring and feel we are long overdue for a price correction. The sad thing about the price correction is that at most it’s 10 percent during recessions.
The housing crash caused a 25% price reduction but was a one time event.
Prices are now above and beyond the last pre-crash peak (2005-2006), so my mental framing of a “good deal” will never happen and $1 million plus on mortgages are now a reality for many here in the Bay Area. Good luck.
Thanks for the post Sam. One aspect I’ve wondered about is your comfort level entering homes, interacting with sellers and others throughout the sales process with the pandemic going on. Sounds like you’re comfortable with this, so I would be interested in your perspective on why or why not.
I’ve just gone to private showings where there’s the listing agent and myself or myself and my wife. We all wear masks and wash our hands.
I’m pretty comfortable when there’s nobody around. And I’m getting more comfortable when more people are around. I believe we are more safe now than 2+ months ago before the lockdown began.
How about you?
I own a few real estate rental properties. Making an offer is like baseball, I’m not going to bat 1000. Because of this, I make numerous offers a year on investment properties.
I find the easiest way for someone who have purchased a home before to get a pre-approval letter is to go back to the lender and relationship person you have used before. They have all your info and might only need a recent paystub. I can usually get an updated pre-approval letter same day or in a couple of days with limited hassle.
That doesn’t mean I need to use that lender. I can still shop around later on if my offer is accepted but it helps in having a pre-approval letter to strengthen my bid on an attractive place.