How pre-approvals can hurt home buyers

Pre-approvals

The newest barrier to prospective home buyers highlights just how competitive the market has become. In the past, the very first step in the home buying process was to get pre-approved for a mortgage. That way, not only would you know what you could qualify for (so you would be looking in the appropriate price range), but that piece of paper would demonstrate to the seller that you were a strong buyer. Of course, the more money you were putting down, the better. Sellers preferred people with 80% loans to those with 90% or 95% loans. However, buyer agents were always pleased when their clients provided a pre-approval letter.

Now, we groan when we see that letter. Why? Because offers that are contingent on mortgages are rarely being accepted! There is so much competition for the few listings available, that the people who have the ability to submit non-contingent offers are winning the bids.

Why don’t sellers want mortgage contingencies?

To understand why sellers prefer cash offers (those not contingent on a loan), here’s a brief explanation: When a buyer’s offer is contingent on a mortgage, he has the ability to terminate the contract and get his deposit money back in three ways.

1. The first is if the property appraises for less than the agreed-to purchase price. That appraisal doesn’t usually come in until about three weeks after the contract has been signed. So the property has been off the market for a while and, if the deal falls through, the seller has lost valuable time.
2. If the best interest rate available to the buyer at the time of closing exceeds the maximum rate designated in the mortgage section of the contract, the buyer can terminate.
3. If, for some reason, once the lender does its due diligence (which occurs after the contract is signed) and determines that the buyer does not actually qualify for the loan, the buyer can terminate.

Conversely, if the purchase is not contingent on a loan, the buyer cannot terminate for any of the reasons above. While this preference has always held true, non-contingent offers have historically been the exception, not the rule.

Today’s landscape

Currently, though, non-contingent offers are virtually the only ones that are being accepted, at least in my market. When I say “non-contingent”, I don’t only mean not contingent on financing, but also not contingent on any inspections! Waiving inspections is a choice that every buyer can make, but the ability to waive the mortgage contingency is not. Buyers who cannot demonstrate that they have the money to make the purchase in cash are unable to compete for the limited inventory.

When will things change?

I am asked this question several times a week. I wish I knew the answer. To see a shift, we will need additional listings and/or  a dwindling of the number of buyers who can write offers that are not contingent on financing. Meanwhile, the big question is what will the buyers who are being shut out of the market do? Rentals are scarce as it is; but my (unpleasant) prediction is that the rental market will become even tighter and more expensive due to the same supply and demand issue. Sellers are riding high at the moment, but I, for one, am hoping for a more balanced market in the near future. Only time will tell….