Are pre-approvals overrated? Tim Wong doesn’t think so. Here’s why
With interest rates low and the property market piping hot, the number of borrowers, both existing and new, asking this question is increasing. So what’s the answer? By going through the process of gaining an Approval in Principle (AIP) or financial pre-approval, borrowers can gauge their borrowing capacity without having to commit to a particular loan or lender.
Within the industry, the value of pre-approvals does tend to polarise opinion. Some brokers take the view that they are not worth the borrower’s effort, given that they are not a binding commitment from the lender. Others believe they can provide the borrower with a much-needed edge in property negotiations, versus one who has not gained pre-approval. In fairness, there is evidence supporting both viewpoints, so we are here to guide you through the maze of questions and facts.
At Zinger Finance, we aim to make our clients aware of all the relevant facts about pre-approvals before they begin the detailed process of applying.
- Is a pre-approval the same as a full approval?
- What are the benefits of a pre-approval?
- Why should I get one and are they even reliable?
- Are there potential credit file implications when seeking finance pre-approval, or in seeking too many pre-approvals within a short period of time?
- What are the possible impacts on your credit file if you do or do not proceed with a purchase?
If you are a borrower considering applying for pre-approval, these are just some of the important questions to which you will need answers before beginning the process.
Let’s remove some of the confusion and explain why, when used correctly, we believe the pre-approval is a valuable weapon in any borrower’s armoury.
What is a pre-approval? Is it the same as a full approval?
Let’s get this clear straight away. As opposed to a full or formal approval, a pre-approval is not a guarantee of finance from a lender. There are a number of differences between the two, and additional steps and conditions need to be fulfilled to turn a pre-approval into a formal approval.
In most cases, pre-approval is only a lender’s indication that they are willing to loan a borrower a sum of money for a property purchase, based on an initial assessment of creditworthiness and borrowing capability. There is no obligation for them to formally approve the loan application for the pre-approval or any other amount when the borrower subsequently finds a property.
Once you have found a specific property, the offer of a full (or formal) approval is an entirely new step in the process, even if a lender has provided you with a pre-approval. The full approval is the lender’s formal offer to lend funds for the purchase of a particular property and therefore for a specific loan amount.
So, for example, you can’t apply for a $1m loan and use $500k now and save $500k for later. This is because having a specific property allows the lender to fully verify the borrower’s application details and check that the identified property is acceptable as security for the loan.
Only upon final approval will the loan application and funds approval be fully documented and binding – and here’s the first benefit! If progressing from a pre-approval, the road to full approval should be fairly quick – around five days, allowing for a property valuation to be done if required.
What are the benefits of a pre-approval?
For you as a borrower, having your loan pre-approved means having a more accurate idea of your property price range, which narrows down your search to a specific location or property type.
It can also relieve the stress and pressure of gathering the relevant financial documents for the lender before full approval, saving you valuable time when the pressure is on. While the details will almost certainly need to be updated, you will already be armed with knowledge of exactly what is required for a full application, having already spoken to a lender/broker about their requirements.
On the other side of the fence, for both the vendor and their agent a pre-approval can provide greater confidence that the borrower is a serious buyer and has taken the appropriate steps towards having their finance in place for a purchase (eg if bidding at auction) – another tick for pre-approvals.
Think of pre-approvals as a kind of ‘trial run’ for your full loan application. They are extremely useful for providing a price range when property hunting, and ensure much of the application work is completed in readiness for a formal application.
What should I consider before applying for a pre-approval?
It all sounds like common sense, doesn’t it? Why would anyone choose not to apply for a pre-approval? Unfortunately, one of the reasons some brokers view them negatively is their variability. Depending on the situation and lender, a borrower’s pre-approval amount may vary considerably, potentially causing more confusion than confidence.
The most common reason for variations is that lenders can approach pre-approvals in various ways, meaning they consider different factors during the initial assessment. This may be reflected in their approval process requirements, the resources allocated to assess each application, or how they prioritise applications awaiting formal approval (eg the probability of the loan settling). In the absence of a consistent approach across the board, there is always significant scope for variability between lenders.
Furthermore, beware of lenders that only assess your stated income and not your full credit situation. They may provide you with a misplaced sense of confidence about your conversion to full approval and borrowing capacity. A more thorough assessment prior to full approval should give a more robust and reliable picture. At Zinger Finance, we prefer lenders who do a more thorough credit assessment (eg liaising with a mortgage insurer), as this increases the reliability of their pre-approvals.
Most pre-approvals are valid for between three and six months. Upon expiry, a new application is needed to ensure your pre-approval is up to date, but keep in mind that most can be renewed or extended if a property has not been found. Once a specific property has been identified, you are ready to move to full approval. Before this can be obtained, the application is subject to the satisfactory valuation of the property and the updating and confirmation of the previously provided pre-approval information.
It is important to remember that pre-approvals can be affected by individual circumstances, as well as factors beyond your control, such as interest rate movement and government policy changes. In our experience, few pre-to-full-approval applications are declined, as long as the client has disclosed all information correctly. For individuals, the main reason for a declined application is that the property is unsuitable to the lender as security, although changes in employment or financial circumstances (eg additional liabilities) can also prove problematic.
Why you should always get a pre-approval
At Zinger Finance, we believe that obtaining a reliable pre-approval is very useful, so treat them like full finance applications (with a few exceptions). For us, the discussion is about more than just how much you can borrow.
In this vein, we don’t submit pre-approvals based on a client’s maximum borrowing capacity. Instead we outline a viable and realistic process for them, identifying the key features and costs and demonstrating how it can help achieve their specific investment goals.
Here are our golden rules for a successful and useful pre-approval:
- When discussing pre-approvals, you must be upfront and honest with your information and about any foreseeable changes to your personal circumstances. This helps remove ambiguities and ensures a more accurate and reliable pre-approval.
- Keep your information to hand and up to date, as time may pass between obtaining pre-approval and finding a property. You should be ready to provide your updated documents quickly for the best chance of success!
- Even with a pre-approval in place, request a cooling-off period or finance clause giving you the opportunity to have your loan formally approved.
- Make sure you don’t unnecessarily use your deposit and money for completion costs while holding a pre-approval.
- Avoid multiple pre-approvals with different lenders. Having multiple AIPs can affect your credit rating, as your credit file will show numerous enquiries with different lenders.
- It is therefore common sense that you shouldn’t seek a pre-approval if you are not seriously considering purchasing. The unnecessary finance enquiry may negatively impact on your credit rating.
- Remember, pre-approvals are not a lender’s commitment to finance! Be aware of the dangers of committing to purchase and exchanging unconditionally on a pre-approval.
Are you ready for pre-approval?
There are both positives and pitfalls in the pre-approval process. However, with a measured and detailed approach, it is a great starting point if you are looking to purchase property and want the comfort of knowing your price range.
Ensure your pre-approval is up to date and from a reliable source. It will accurately guide your search for your next purchase and potentially help you beat your competition to the punch, when it comes to signing on the dotted line.
Tim Wong has over 10 years’ experience working in the Australian banking and finance industry, having previously worked with Westpac, Wizard Home Loans and GE Money before joining Zinger Finance.
Disclaimer: The views provided here are of a general nature only and should not be taken as financial advice. Please speak to a qualified professional before making any financial decision.
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