Monday, April 10, 2023

Are Pre-Qualifications Masquerading as Pre-Approvals Illegal? DFI Says "Yes"

DFI Says "Yes" - it's a "Misleading and Deceptive Act." CFPB calls it "deceptive."

  • "I issued a pre-approval for a buyer and the lender wouldn't do the loan, so they had to pull the contract."
  • "I've been told a pre-qualification is worthless."
  • "If I have DU approval and docs, I can do a pre-approval."

As refinance volume dwindles and the spring housing market goes into full overdrive, these good questions increase. This is a minefield for brokers. It comes down to literal definitions. And, where it previously was an ethical issue, states now will cite brokers for pre-approvals that were not backed by a lender's approval. 

From the WA DFI

A Pre-approved mortgage means approved before the property, NOT approved before underwriting. If a loan is ready to close subject to an appraisal, that is a pre-approval. As you know, AUS approval doesn't mean ready to close. Approved means you, as a banker, are prepared to lend the money. Everything else is a pre-qualification.

Consequences of Fictitious Approvals

Some regulators will cite you - as a broker with no warehouse line or funds to make a loan - for approving a loan. You can also be sued by a seller or buyer for misrepresentation if the loan is delayed due to approval issues. In this market, where people submit contracts without a financing contingency, this becomes even more worrisome. 

Specifically, buyers expose themselves to legal action if they cannot perform under a contract. Though brokers are not parties to the contract, if their representations cause the action, then they become culpable.

Do the work up-front and get the loan approved by the lender (TBD) before you send the borrower out shopping. If your lender doesn't approve loans without an appraisal (TBD), find another lender who does pre-approvals. 

There IS Value in Pre-Qualification

Incorrect use of the term "pre-approved" connotes approved, subject to underwriting approval, which is contradictory. Pre-approval actually means "approved, subject to an acceptable property." (AKA TBD approval) The real estate industry has driven this confusion by recognizing that a pre-approval is better than a pre-qualification to satisfy a seller deciding between two offers; choose one with or without approval. Agents demanding instant pre-approvals have pushed originators to call a pre-qualification a pre-approval. Without underwriting, however, this is a fabrication.

A pre-qualification can include: "We have reviewed the documents and have received an automated underwriting approval; however, the loan request is still subject to lender approval." We suggest this because even with automated underwriting, without a review of the underlying documents, changes can invalidate automated underwriting approval. For instance, if the originator uses a salary for the income when the wages are actually variable, automated underwriting results will change accordingly. 

Does this mean pre-qualifications are useless? NO! Prequalifications are very valuable, but they represent an earlier stage in the process, the first step. The pre-qualification process allows the originator to address a customer's realistic expectations for affordability. Once you address any customer issues, you can request pre-approval and submit an application for approval through a lender's underwriter. Once approved, you can send the borrower into contract negotiations with financing contingencies waived.

Furthermore, brokers should maintain loans not submitted to lenders in their "prospect" pipeline as pre-qualifications to avoid triggering reporting requirements and excess regulatory responsibilities. The fact that an applicant has triggered the requirement for a Loan Estimate does not automatically mean the loan is an "application." It can still be a pre-qualification.

Ethical or Illegal?

While this is primarily an ethical issue, not a legal one, the CFPB is focusing more on "deceptive acts and practices" and saying a loan is approved when it is not falls into this category. It does not rise to a civil legal matter until someone cannot deliver on a "pre-approval" and the loan does not close. Then the consumer, and anyone else who relied on the misrepresentation, can take action under breach of contract, fraud, etc., because they have a cause of action. Some states (such as Virginia and Washington) have mandated that the term "pre-approval" be accompanied by an actual loan offer. What that means is subject to interpretation. It is often difficult to prove misrepresentation when there is no harm - e.g. the customer doesn't take action. 

Ethically, calling a loan approved when it is not ready to close - or the conditions precedent to closing have not been stipulated in a way that could be met by a reasonable person - is a misrepresentation and a deceptive act. 

TBD - Property to Be Determined

The term TBD is the industry jargon for approved, subject to property. That is a correct term.

There is no distinction between which origination channel - e.g., retail lender or broker - that makes calling a pre-qualification a pre-approval right. It's a misrepresentation if the loan isn't ready to close as described. However, a lender who can make loans from its own proceeds certainly can "chance it" based on internal criteria knowing that a loan is "approvable" if AU is correctly applied. A broker cannot "make" a loan - they are brokers. A broker's approval "subject to" is the lender's institutional letter of approval, not the broker's. Technically and logically, a broker could expose him or herself to liability when acting as a lender when, in fact, a broker - e.g., "making loans." A case in Iowa brought this to a head when a broker failed to deliver a loan after issuing a pre-approval. 

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