Home Loan Pre-Approvals

Beware - most Pre-Approvals are not worth the paper they’re printed on

It is our belief that the term Pre-Approval is arguably the most ill-defined, misleading and dangerous term used in the mortgage industry.

It means different things to different people and varies greatly between Lenders.  What it almost never means is what the name implies – and what most people think it means. 

The term implies – and our experience is that many people believe it means – that the borrower is pre-approved for a loan.  That is, all they need to do is find a property that meets the loan amount they have been pre-approved for and they can safely move forward with an unconditional purchase contract.

In fact, we see many people blindly moving forward at auction – a ‘fall of the hammer’ arrangement – based on a so-called home loan pre-approval.  (See our Auction Fact Sheet for more regarding what you need to know about Auctions)

Pre-Approval is also often used synonymously with “conditional approval”. 

Conditional Approval is probably a ‘safer’ term as the name at least implies there is some sort of ‘condition’ that must be satisfied in order to gain a full approval (“Formal Approval”).

However, we then see many Mortgage Brokers and home purchasers referring to a Conditional Approval as a Pre-Approval – despite the document not saying that. 

And the internet is full of mortgage brokers, banks, and real estate agents telling you that a pre-approval is all that is required (or has some other mystical qualities). 

It is very important to note that ALL of these people are salespeople and none of them are required to act in your best interests.

Before we go any further – let’s acknowledge that it is perfectly understandable for someone who is about to begin negotiating on properties in earnest – and certainly someone who is about to bid at an Auction – to want to achieve a genuine Pre-Approval.

Couple this with the fact that most Real Estate Agents won’t give would-be purchasers the time of day until they are provided with a copy of the “pre-approval” (or at least a verbal assurance that one has been obtained) – then it is no wonder that home buyers, especially first home buyers, find themselves giving far more weight to a pre-approval than they should.


Confusing Terminology

As mentioned previously, the term Pre-Approval is ill-defined.  We see it regularly used to describe any of the following:

A.   The highly marketed “5-minute pre-approval” at the local Bank Branch.  This is nothing more than an assessment of borrowing capacity undertaken on information provided by the borrower and that has not been substantiated or reviewed by the Lender.  It comes with a list of conditions ‘as long as your arm’ – and therefore should never be called a pre-approval.  But because it is on Bank Letterhead and titled ‘Pre-Approval’ (or says “Congratulations your home loan has been pre-approved”) many people place far too much reliance on this document.  At the end of the day it’s an assessment you can undertake yourself using that Lenders online borrowing calculator (aka servicing calculator).  A diligent mortgage broker, although not the decision maker, can provide a much better indication of your borrowing capacity as they can look across the credit policies and servicing calculators of multiple Lenders.

B.   Pre-Approval following making a loan Application.  Just to add to the confusion this will also be referred to by many Lenders and mortgage brokers as a Conditional Approval or Preliminary Approval.  A full loan application may have been made – but in the absence of an executed Contract of Sale very few Lenders fully review the application or supporting documents.  At best they will run your credit file, check the Application for basic completeness, and confirm the servicing position.  But again, all of this is done at a rudimentary and surface level.  At this stage there has not been a proper credit assessment undertaken and the file has probably not left the desk of a lower-level administrative person (i.e. not a decision-maker).  Many Lenders will issue this type of Conditional Approval within half an hour of the loan file being submitted – clearly indicating that no assessment at all has been undertaken.  Borrowers – and even many mortgage brokers – are then shocked to be asked for significantly more information and documentation once a Contract of Sale has been provided.  And very shocked if the loan is ultimately declined.

C.    Conditional Credit Approval – following full credit assessment and requests for more information as required.  Ostensibly the only remaining “condition” should be the valuation of the property once identified.  This, and only this, can legitimately be called a pre-approval of your loan.  It is certainly what we believe is the minimum you need before going “unconditional” on a Contract of Sale (although a Formal Approval – aka unconditional approval – is better).  The problem, as explained above, is that almost no Lender will undertake this level of work until such time as you provide them with an executed Contract of Sale.  So, it’s a catch-22.


Better Terminology

In order to more clearly define things for our Clients – we prefer to use the following terms and processes:

  • Initial Review – we do this after you have completed a full Fact Find – which includes providing us with detailed asset and liability position, income, and cost of living expenses – as well as your goals and objectives.  For self-employed borrowers we will also ask for your two most recent years’ personal and business tax returns and financial statements.  While we want to make it very clear that we are not the decision-maker on whether your loan will be approved or not, we then undertake a robust assessment of your borrowing capacity across multiple Lenders servicing calculators and credit rules.  This process is far more detailed and rigorous than either A or B above.

  • Approval in Principle – this roughly equates to a "Pre-Approval following making a loan Application" – except that we will be very clear what has and has not been assessed.

  • Conditional Approval – always following a full loan Application and assessment.  Again we will be very clear what conditions still need to be satisfied.

  • Formal Approval – this means the loan is fully approved and the Lender is about to issue loan contracts.  Note: A Formal Approval may still contain some ‘conditions precedent to settlement’ but the loan itself is fully approved.


ALL Pre-Approvals have a shelf life

In almost all cases a pre-approval (of any type) will lapse after 90 days. 

While most pre-approvals aren’t worth the paper they’re printed on anyway – this is still an important point to note, especially if you expect to take some time to find your ‘dream home’ or if you are buying ‘off the plan’ (refer to our separate Off the Plan Fact Sheet).


So why do Lenders and Mortgage Brokers like to offer pre-approvals?

The answer is very simple – it is good (for them).  Their goal is to “take you off the market”.

Basically, when a Lender issues you a pre-approval, or a mortgage broker arranges one for you, they know that you’ll stop doing research on which Lender or mortgage broker you want to use and focus only on finding a property.

This way they also have you pretty much trapped.  Even if you start thinking about whether you could be getting a better deal after you find a property – the Lender or Mortgage Broker is hoping that time will be against you and/or it’s all just too hard to go through the process again.

Editor’s Note:  it never ceases to amaze us how people will haggle to get that last few thousand dollars off the purchase price of their home and then blindly pay $50,000 or $100,000 more in interest fees and charges on their home loan than they need to.


So – what’s the solution?

I guess what you’d expect us to say is use our services and follow the process of ‘Initial Review’ – ‘Preliminary Approval’ – ‘Conditional Approval’ – ‘Formal Approval’.

And you’d be right!

However, what we’d also say is, wherever possible, avoid going unconditional on a Contract of Sale until such time as you are in possession of a Formal Approval.  Consider using a finance clause where you can.

This is not possible at Auction and generally will not be allowed by the Vendor if you are negotiating ahead of an Auction.

It also isn’t possible for off the plan purchases.

In these cases – don’t rely on flimsy pre-approvals.  Use our services, or the services of a reputable and diligent mortgage broker, to undertake a detailed initial assessment across multiple Lenders.

Make sure you are completely open and honest and make full disclosure so that you get an accurate assessment.

Beware of self-professed experts who tell you that you don’t need a finance clause, or any other form of protection, if you already have a pre-approval.  We normally hear this sort of ‘advice’ from:

  • Real Estate Agents – who clearly don’t have your interests at heart at all.  They are paid by the Vendor and work solely in their interests.  They are also not qualified or legally entitled to give credit advice or legal advice – but that won’t stop them if they think it will help them make a sale (and earn a fat whack of commission); and

  • Conveyancers (sadly).  Note:  We have never heard of a qualified Solicitor giving such poor advice – but we are more and more hearing it from some Conveyancers (usually ones whose hair is still wet from the womb and haven’t yet seen the sorts of disasters that can eventuate).  Conveyancers are not licensed to give credit advice.  There are also some definite limitations on their capacity to give legal advice.  As the name implies, they have the training and licensing to allow them to act on a property conveyance.  They certainly do not possess the intimate knowledge of the rapidly changing mortgage market or individual Lender policies that their bold claims would have you believe.


Conclusion

As has been mentioned it is perfectly natural for prospective home buyers to want to have some level of assurance about their purchasing power before negotiating in earnest or attending an Auction.

It is equally reasonable to ask a mortgage broker or Bank lending officer to provide an indication of maximum (we would prefer conservative) borrowing capacity.

This Fact Sheet is not intended to dissuade you from undertaking this logical preliminary step.

Rather, what we hope it achieves is to assist you to frame the conversation in a much better way and allow you to avoid the traps set by those that are far more focussed on a sale than on acting in your best interests.

If you have any questions or need any assistance - please feel free to Contact Us.



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If you have been directed to this Fact Sheet by your Independent Mortgage Planner it is in order to allow you to review some relatively detailed considerations in your own time and at your own pace. Only any specific advice subsequently, or previously, provided by your Independent Mortgage Planner constitutes personal advice. In all other circumstances, the information provided in this Fact Sheet is general in nature only and does not constitute personal advice. The information has been prepared without taking into account your personal objectives, financial situation or needs. Before acting on any information in this Fact Sheet you should consider the appropriateness of the information having regard to your objectives, financial situation and needs. Before making any decision, it is important for you to consider these matters and to speak to an Independent Mortgage Planner. We provide Credit Advice only. You may also wish to seek appropriate legal, tax, and other professional advice.
 
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