In this area, virtually all offers to purchase residential property are accompanied by a pre-approval letter. Ostensibly, these letters “guarantee” a buyer will get the loan he needs. In fact, pre-approval letters can run the gamut from assurance of a loan to a quickly prepared note that is worthless. As a buyer or seller, knowing the difference will prevent potentially serious problems.

Formerly common, a pre-qualification letter showed the buyer had “talked” with a lender and would likely be granted a loan. Over time, however, “pre-qual” letters have become less acceptable and pre-approval letters are now de rigueur.

Years ago, a pre-approval letter was a communication directly from the bank, or a mortgage broker working with the lender. It stated that all aspects of the buyer’s ability to purchase had been verified and only a satisfactory appraisal and preliminary title report were necessary.

At one time, the pre-approval letter meant something. Unfortunately, many buyers, sellers, and their agents do not fully appreciate that today’s pre-approval letters are often “faux-approval,” not any better or more reliable than the now disparaged pre-qual.

A comprehensive and effective pre-approval letter will state that the buyer has good credit and all funds necessary to close escrow are available. In most cases, his employment and income must also be confirmed.

Prior to the seller accepting an offer, and with the premise that a pre-approval letter may or may not mean what it says, it is crucial for the listing agent to call whoever prepared it. When I do this for sellers, lenders frequently tell me they are surprised to hear from me.

Agents should ask, who is the lender making the loan? Mortgage brokers are middlemen; they arrange loans, but usually do not provide the money. If the lender has not been determined, and the mortgage broker is not also a mortgage banker, this clearly cannot be a pre-approval.

More questions to ask when calling: Has the source of funds been verified? Where are these monies? Are they liquid? The full story is not always what the buyer’s agent presents or the lender writes.

At times, a buyer will be getting money from a home equity loan, i.e., he does not have the cash and will need to borrow it. This could be fine if there is sufficient equity in the other home, but what if the buyer or property cannot qualify? In addition, has the loan been applied for, or, if not, how long will it take? Now the seller must worry about the buyer getting two loans, not just one.

Similarly, if the buyer is counting on proceeds from a retirement plan, that could delay the close, or, possibly, prevent it if the money is not forthcoming.

Another possibility is that the buyer’s cash is from another type of loan, such as a private one. If, for some reason, it does not come through, the buyer will not be able to complete the purchase.

Where money is from family, a letter from the one supplying the funds, along with written documentation of the cash, should be provided. A short time frame to transfer these assets to the buyer’s account is prudent.

In the instances above, a competing buyer with less, but liquid, cash may be preferable.

As those looking to buy continue to surpass available homes for sale, contracts written without loan contingencies have been increasing. Agents tell their buyers that, in competition, a financing contingency could prevent them from getting the property they love. With pre-approval letter in hand, a growing number of Realtors omit this contingency without fully considering and explaining the possible consequences for both the buyer and seller. This is a bad trend because it is not working in the best interests of buyers or sellers.

Most loans eventually close; however, unsuspecting buyers and sellers may be in jeopardy if they make irrevocable plans based on a pre-approval letter and the lack of a loan contingency. For example, if a naïve buyer purchases a car during the transaction, he may no longer qualify for the loan.

The same could be true if the buyer suddenly loses his job and the lender, when doing a final audit before granting the loan, hears from the employer that the buyer’s job will be ending soon. Likewise, if a previously unmentioned child support commitment surfaces before the loan funds the buyer might lose his financing.

If interest rates get back down to the 5% level and the refinance craze begins again, funding could be delayed. With a late close and no loan contingency, the buyer could be liable to the seller for damages.

Aside from losing a house you want to buy, what are the possible consequences of not getting a loan when you have a pre-approval letter and no loan contingency? You may lose your deposit, or, depending on contract language, you might have additional liability. As a seller, your plans could be ruined, costing you money and heartache. In addition, you may end up with a much lower selling price when remarketing the home. In this regard, buyers and sellers should understand the Liquidated Damages clause in the contract.

Some direct lenders (banks or mortgage bankers) may argue that, since they issue the loan themselves, without a middleman, my admonitions do not apply. Nonetheless, if questioned (and I have asked many) whether they “sometimes” write a pre-approval letter without total documentation, they confess to having done so. In those cases, their pre-approval letter is simply a gussied-up pre-qual letter.

For a topic that deserves maximum attention and disclosure, pre-approval letters are either not discussed or are glossed over by many real estate licensees. Should this matter to you? Yes, if, as a buyer or seller, you are counting on that lender to perform.

Related Articles: Unwritten Contingencies; What are Liquidated Damages; and Loan Processing Paralysis Causing Delays