What is a pre approval home loan?
An application for a pre-approval home loan is a request for a home loan assessment before finding a property. Typically, a lender assesses your eligibility for a home loan based on your current financial position. You usually indicate the property type you are searching for and loan amount you anticipate needing as part of an application for pre approval.
A pre approval home loan application is very similar to a regular home loan application. Importantly, it will register as a credit enquiry on your credit file. The main difference is the lender assesses the home loan eligibility of the borrower only, and reserve the final assessment when a property is found.
Once a property has been found, and a purchase agreement entered into, a pre approval home loan can then be converted to a regular home loan application, and hopefully an unconditional approval.
How does a pre approval home loan provide an edge?
A pre approval home loan can give buyers an edge in a competitive property market.
When a seller reviews multiple offers to purchase, all other things being equal, they can be more likely to accept an offer from a buyer with pre approval over a buyer without pre approval.
Pre approval can be an optional step in the home loan approval process.
So, while pre-approval is not mandatory for home buyers, there are several reasons why it can be beneficial. Here are five reasons prospective buyers obtain a pre-approval home loan:
Buyer confidence
Pre approval from a lender can give buyers confidence that their home loan stands a good chance of unconditional approval once they find a property. It makes the dream of homeownership tangible, so they can make offers on properties with confidence.
Seller attraction
A pre-approval home loan can make a buyer more appealing to sellers in a competitive market. It can provide the extra assurance needed to convince both the seller and their real estate agent to accept your offer to purchase.
When a seller is comparing any offers to purchase their property, one key consideration is to identify major obstacles to a smooth sales process. A buyer’s finance requirements, often disclosed in a contract under a ‘finance clause’, can be a major reason for a slow sales process—or cause it to fall over. A pre approval home loan can set aside any concerns a seller might have about the strength of a buyers financial position.
Buying at auction
Auctions require property buyers to do their own due diligence before bidding.
A pre approval can form part of this process to reduce any risk associated with arranging finance after a successful bid at auction. While it is not the same as unconditional approval, it can provide a higher level of certainty that the eventual home loan application will be approved.
Outside the square
Sometimes a home loan application seems strong and, on the face of it, ripe for approval. But many home loan applications have elements to them that fall outside the home loan approval guidelines set by lenders.
In cases where a home loan application may be considered “outside policy”, seeking a pre approval home loan assessment can provide clarity for the buyer around their eligibility for a home loan.
Planning to build
When considering a land purchase, buyers would normally be interested in building as well. Most buyers want to avoid a situation where they successfully purchase land but cannot borrow the funds to build.
A clever way to structure an offer to purchase land is to tie in a finance clause that requires both finance approval for the land purchase and pre approval for the construction funds. I recommend legal and financial advice when it comes to drafting any contract clauses.
What is the pre approval home loan process?
The pre approval home loan process starts with you wanting to one day be a homeowner. The sooner you meet with a mortgage broker or lender the sooner you can implement any plans for home ownership.
Preapproval is an optional step in the home loan approval process and is something a mortgage broker can assist with, or you can do directly with a lender.
Initial meeting
Meeting a mortgage broker or lender can be helpful early on in your home buying journey. Here is where you should find be given an opportunity to identify any goals and objectives that might relate to your financial and property journey.
A good outcome of this meeting would be that you have a clear idea of what the home loan approval process entails and that any subsequent financial decisions you make are with your home ownership goal in mind.
Prepare for pre approval
As in any regular home loan application, a pre approval normally requires verification of all aspects of your application. This usually covers areas of identification, income and financial position. I have prepared a document checklist that provides an overview of what might be needed to support a pre approval application. Your lender or mortgage broker should provide a list that is specific to your circumstances.
Submit application
A pre approval application should require everything a standard home application requires, except a property. A thorough pre approval assessment will require verification of all aspects of you application.
At this stage a pre approval home loan assessment is submitted to the lender directly or via a mortgage broker.
Usually, the only thing missing from a pre approval at this stage is the property.
If a lender decides to pre approve you for a home loan this means they are comfortable in your ability to repay the home loan applied for based on your current financial position. However, given no property is presented with the loan application they can only offer a pre approval.
Pre approval has other names
A pre approval is the generally accepted term for a home loan approval without a property. If all goes to plan, once a suitable property is found it should be converted to an unconditional approval.
Pre approvals are referred to in other terms, some a branding effort by banks, and others just a substitute term. Generally-speaking, the following terms often refer to a pre approval:
- Approval in principle
- Home seeker
- Conditional approval
- Indicative approval
The common thread with all of these is that they are home loan approvals with conditions. The conditionals are usually significant and leave scope for a lender to take a second look at all aspects of the application when a suitable property has been found.
What are the conditions of a pre approval?
It is important to understand that a pre approval with conditions is where the risk can lie for would-be borrowers. A pre approval should not be confused with “cash”. Any release of funds is very much dependent on the borrower meeting all conditions of the pre approval.
Specific conditions imposed by a lender for a pre-approval may vary, but there are common themes shared among lenders in Australia. Below are some examples of the conditions lenders may specify for a pre approval home loan:
- Loan amount limit
- Lenders mortgage insurance
- Financial position
- Property type
- Loan to value ratio maximum
- Loan repayment type
See the home loan approvals process flowchart for more information around where the pre approval fits.
Risks of a pre approval home loan
When is a pre approval strong or weak?
What are some aspects of a pre approval to look out for?
Here are some ways a pre approval can let down borrowers when it really matters.
You apply when you are not ready
A half-hearted pre approval application can lead to a decline and affect your credit score. Be sure to understand that an application for pre approval is still a request for credit and can have implication on your credit score.
Some pre approval home loan approvals are weak
Some pre approval home loans can be light touch, often referred to as ‘system-generated’. The level of assessment for pre approvals from these lenders is significantly less thorough than a regular home loan assessment. This begs the question: Why do these lenders pre approve at all?
Perhaps the answer lies in their speed. Given there is no need for human intervention the turnaround time can be comparatively quick.
System-generated pre approvals depend largely on a combination of credit scoring, lender-specific formulas and accuracy of the home loan application details provided.
The potential risk to the borrower is that a pre approved home loan can still be declined if a person manually assesses the file and identifies any inconsistencies in the application as presented.
The room for error often plays out during the final assessment stage which is done after a property has been found. Only then, will the home loan application be analysed for completeness and accuracy.
A system-generated pre approval can still provide buyers with the edge they need in a competitive property market. However, given it passed through a system with minimal checks and balances, the confidence level that should be taken from this type of pre approval should be tempered.
If your reason for seeking a pre approval is to minimise your chances of home loan application being declined, then a more thorough pre approval assessment could be considered. Alternatively, if an experienced and quality-focussed mortgage broker is comfortable with this approach, then they should provide you with any pros and cons for this approach.
Pre approvals expire
Home loan pre approvals last for 90 days.
Some lenders might say their pre approvals last 6 months, but the law requires any home loan credit proposal to be revisited after 90 days.
Pre approval home loans can fail a borrower when they wrongly assume that it is valid for longer than it is.
While this time-period can pass quickly, it can be refreshed—with a bit of work. The process of buying a home can take a while, so if a valid pre approval is a key part of your home buying journey then keep an eye on your expiration date.
To minimise any risk of your home loan application being declined, your period of preapproval is a valuable time to be in close contact with your lender or broker.
House prices risk
If you have read anything about prices recently you will know that they move. In case of rising property prices it can often mean bigger loans.
A pre approval may offer a level of comfort around borrowing capacity but only up to the home loan limit applied for.
In the case where you need to request higher limit than your pre approval allowed for it can fail at a couple of levels:
- Your preapproval might not provide the competitive edge you were hoping for because the loan limit is less that what you need—introducing some doubt around your financial strength.
- In requesting a higher loan limit than was pre approved, your loan application should trigger another full assessment. This may be okay for strong applicants but for borderline pre approvals the outcome can be very uncertain and perhaps leads to a decline.
Lenders mortgage insurance risk
It is not uncommon for a lender to approval a loan only for lenders mortgage insurance (LMI) to decline it. In the case of a pre approval home loan the impact of LMI, and any risks associated with it, needs to be understood at pre approval stage.
Property risk
Let’s not forgot your pre approval home loan is lacking in the one thing banks need—property.
Any buyer with pre approval should have done appropriate research into the types of property a lender will be willing to accept to complete the home loan approval process. For instance, a lender might be comfortable using one property type for a 95% LVR home loan but only extend to 70% LVR on another property type.
A home loan application can be declined after pre approval stage if the property the buyer agrees to purchase is not suitable. Hopefully this is something a buyer is well educated around during the pre approval process.
Not a priority
Pre approvals enable lenders to capture future customers early in their home buying journey. However, if lenders need to prioritise time and resources to deal with high volumes of new loan applications, pre approval queues normally blow out.
Lenders can also put a temporary pause on the assessment of applications for a pre approval home loan in times where they need resources elsewhere.
Time is everything and if you are reliant on a pre approval home loan then assessment timeframes should be part of an early conversation with your mortgage broker or lender.
FAQs
What is pre-approval for a home loan?
A pre-approval for a home loan involves requesting a home loan assessment prior to finding a property to purchase. The lender assesses your suitability for a home loan based on your existing financial situation. In the loan application, you would typically specify the type of property you are expecting to purchase and the loan amount required.
Do I have to get pre approval?
No. Some real estate agents may request it as part of their process for qualifying offers though, especially for auctions.
How long do you have with a pre-approved home loan?
A pre approval home loan lasts 90 days before it needs to be revisited. Extending the duration of the pre approval will depend on lender requirements. It could involve a light touch approach, like a declaration that your financial position is unchanged, or something more comprehensive, like another assessment with renewed and updated documentation.
Can you put an offer on a house without pre-approval?
Yes. Pre approval may give you an edge in a competitive property market but is not usually a requirement.
Is pre-approval unconditional?
No. Pre approval is not the same as an unconditional approval. A pre approval home loan will come with conditions, like the requirement for a lender to conduct a property valuation once found. By having conditions attached to a pre approval, it cannot be unconditional.
How long does a pre approval take?
Assessment of a pre approval home loan usually takes around two weeks for a comprehensive assessment. It takes a similar amount of time to a standard loan application.
Is there risk with pre approval?
Yes. There is risk. If a lender imposes conditions on a pre approval that cannot be met when a property has been found, it is unlikely to progress to unconditional approval.
There is also risk that individual circumstances could change. You can lose a job which could significantly affect any affordability calculations.
How long does a preapproval last?
A pre approval home loan usually lasts for 90 days before lenders and mortgage brokers need to review your position.
Final word
A pre approval home loan is an indication a lender is willing to lend to you, once any conditions of the pre approval have been met—most notably finding a suitable property.
A pre approval has been known to give buyers an advantage in a competitive property market. It shows sellers they have done their due diligence and are committed to the home buying process. Sellers naturally like to avoid the prospect of a sales process falling over, with finance often the cause. A pre approval home loan provides some assurance to sellers that finance will not get in the way of a smooth sales process.
For all the appeal of a pre approval, it can also let buyers down if they are not educated or informed.
Pre approvals have an expiry date.
Pre approvals come with conditions that still need to be met.
Pre approvals from different lenders are not necessarily equal.
There is place for the many types of pre approvals in the Australian home loan market. A good mortgage broker can advise how and if a pre approval home loan can be used for your circumstances.
