A finance pre-approval is a valuable tool for home buyers, especially in a competitive market. But not all finance pre-approvals are equal, and they do have their risks.
What is a finance pre-approval?
A finance pre-approval is a written commitment from a lending institution that they will provide you with a home loan if you meet certain conditions.
A finance pre-approval can also be called an indicative approval, a conditional approval, or an approval in principle. The key point is that a pre-approval shows that your application fits the lending institutions loan guidelines, but the approval is still subject to conditions.
A finance pre-approval isn’t a guarantee of finance. Instead, it’s an offer of finance subject to terms and conditions set by the lender, including:
- A satisfactory valuation confirming your loan will remain within the loan-to-valuation (LVR) set by the bank
- Confirmation that your employment hasn’t changed
- Confirmation that your financial position hasn’t changed
- Your agreement to the lender’s standard terms and conditions.
How to obtain a pre-approval
A finance pre-approval can only be obtained by a formal, written finance application to a financial institution. This means you’ll need to provide the lending institution with all the required supporting documents including your pay slips and bank statements.
The process can take 2-4 weeks depending on the complexity of your circumstances.
Types of finance pre-approvals
There are two key types of finance pre-approvals.
System generated pre-approvals
System-generated pre-approvals are obtained online by providing the bank with a limited amount of supporting documentation. The information you provide is then processed by software to provide you with a pre-approval. As the approval has been decided by software and not verified by a human, system-generated pre-approvals are subject to many conditions.
You should never make an unconditional offer on a property relying on a system-generated pre-approval.
Fully assessed pre-approvals
An assessed pre-approval is obtained when the lending institution’s credit team conduct a manual assessment and verification of all the information and documents provided in support of the application. In addition, a credit check is performed by an independent credit assessment agency.
An assessed pre-approval will still be subject to your financial circumstances not changing between the date of the pre-approval and your final application. It will also be subject to the receipt of an acceptable valuation of the property you are buying along with any other property you plan to offer as collateral.
Because there is more work involved in obtaining an assessed pre-approval it takes longer.
Why is a pre-approval so important?
There are a few strong reasons to obtain a pre-approval prior to making an offer. These include:
- A finance pre-approval will improve the chances of your offer being accepted by the seller.
- A finance pre-approval gives you a firm guide to work with, so you are less tempted to get carried away on auction day or in a competitive bidding scenario.
- A finance pre-approval will reduce the likelihood of your finance falling through and thus missing out on your dream home.
- A finance pre-approval can give you the confidence to bid at auctions. Despite sometimes intense competition, auctions often provide great opportunities to buy a property at a great price. But, before bidding at auction, it’s important to remember that a finance pre-approval isn’t a guarantee that the lender will fund a loan. There are many reasons a finance pre-approval can be later withdrawn, as described below.
Things to do before obtaining a finance pre-approval
There are a number of things you should do before obtaining a finance pre-approval, including:
- Choose a good broker. They’ll make all the difference in understanding the complexities of financing your property transaction.
- Make initial inquiries with the broker or lending institution to find out if you qualify for a home loan and, if so, for how much.
- Decide on the type of home loan you want. Each is different with different facilities, fees and interest rates. Don’t get sucked into thinking the cheapest rate will be the best loan for your circumstances.
- Conduct some research to find out if you can get what you want with the amount you can afford.
- Get a feel for the market. Visit home opens, attend auctions and talk to real estate agents. It’s important to arm yourself with as much information as possible before taking the next step.
- Clear away the mental and emotional roadblocks that will stop you from purchasing, if you find the right home. See point 3 in the next section.
What are the risks of a finance pre-approval
- Finance pre-approvals have an expiry date, often after 90 days (about 3 months). If you don’t complete your purchase and make your final finance application before the expiry date, then the commitment made by the bank is no longer in force.
- It’s not a complete guarantee and may be withdrawn. See below.
- A finance pre-approval is noted on your credit history. If you don’t take up the offer and reapply too often it can become a negative mark on your credit score. Only get a pre-approval if you’re serious about buying.
- A finance pre-approval has no relationship to the value of the property. It’s still important to do your research. Make your offer for an amount that’s less than or equal to how much the research tells you the property is worth.
When can a pre-approval be withdrawn?
There are a number of reasons a pre-approval can be withdrawn by the financial institution including:
- You change your job
- You salary is reduced
- Your hours are reduced, or you change the basis of your employment e.g., from full-time to part-time
- You apply for more debt e.g., a new credit card or personal loan
- You don’t meet the loan-to-valuation (LVR) target set by the lender e.g., by being unable to provide the required deposit or equity.
- The LVR changes because of the property you’ve bought and you’re unable to come up with the equity to come up with the shortfall. This is common with the purchase of apartments smaller than 50 m2 (bedsitter units are often affected).
- The LVR requires that you need lender’s mortgage insurance (LMI) and you don’t meet the requirements of the LMI provider.
- You have a credit ‘accident’ e.g., default on a loan payment
- You can’t provide the required evidence in support of your loan application e.g., pay slips, proof of savings
- The lender’s credit policies change, and you can’t meet the new requirements
- Interest rates increase and you can no longer afford the amount you were originally approved for
- The property you’ve bought was valued at less than you paid
- The property you bought is unacceptable as security to the lender. This may result where, amongst other things. the property:
- Is in close proximity to high tension power transmission lines
- Is in a suburb or location that the lender considers to be unacceptable
- Is in a high rise apartment complex
- Is in an apartment complex where the lender already has significant exposure through other loans
- Is smaller than the lender’s minimum size policy, usually 50 m2.
- Is in a state of disrepair
- Is a property type deemed unacceptable to the lender.
Can I buy at auction or make a cash offer with a finance pre-approval
If you require any sort of finance in order to complete a purchase, it’s not advisable to make a cash offer or bid at auction.
Most auctions contracts are cash, unconditional. Except in rare circumstances, if you’re the successful bidder at an auction, you’re guaranteeing the seller you’ll be able to pay the full purchase price on settlement.
It’s not uncommon for buyers to buy properties at auction relying on a finance pre-approval. But the risks are real as described above. And, because of these risks, buyers should check with their broker or lending institution first.
If you are the successful auction bidder or your unconditional offer is accepted and your finance is later declined, you run the very real risk of losing your deposit, at a minimum.
Despite their risks and shortfalls, a finance pre-approval is your best option and will give you a solid competitive advantage when it comes to securing your dream home. It will give you a strong, competitive advantage and more certainty of securing your dream home.
If you require help to obtain a pre-approval call Ryan Tripi Now on 0407 007 386
