How does a Pre-Approval work? Do I need a Pre-Approval?
What is a Home Loan Pre-Approval?
A home loan pre-approval (also known as conditional approval or approval in principle) is an initial assessment conducted by a lender, after which they agree, in principle, to lend you a certain amount of money to buy a property. It's essentially the lender saying, "Based on what we know about your finances right now, we'd be willing to lend you up to this amount."
Pre-approval is not a binding guarantee of finance, but rather an indication of your potential borrowing capacity. It serves as an important first step in your home buying journey, giving you a clearer picture of your budget before you start property hunting in earnest.
How the Pre-Approval Process Works
Step 1: Research and Preparation
Before applying for pre-approval, it's advisable to:
- Calculate your borrowing capacity using online calculators
- Get your financial documents in order
- Check your credit score
- Research different loan options
- Have a clear idea of your property preferences
Step 2: Application Submission
To apply for pre-approval, you'll need to provide documentation including:
- Proof of identity
- Income verification (pay slips, tax returns)
- Details of assets and liabilities
- Information about your expenses
- Bank statements
Step 3: Assessment
The lender will assess your application by:
- Checking your credit history
- Verifying your income and employment
- Reviewing your assets and liabilities
- Analyzing your spending habits
- Calculating your borrowing capacity
Step 4: Decision
The time it takes to get a conditional approval depends on your individual circumstances. In some cases, it takes just a few hours. In other cases, it may take a few weeks. If your application is approved, you'll receive a pre-approval letter or certificate that typically includes:
- The maximum loan amount you're pre-approved for
- The expiry date of the pre-approval
- Any conditions that must be met for full approval
How Long Does Pre-Approval Last?
Most pre-approvals are valid for three months (90 days), although the timeframe may vary between different lenders. Many lenders offer the option to renew at the end of the 90-day period, provided your financial situation hasn't changed.
The limited validity period is in place because:
- Your financial situation may change
- Interest rates may fluctuate
- Lender policies may be updated
- Property market conditions can shift
Benefits of Getting Pre-Approved
1. Know Your Budget
Perhaps the most significant advantage of pre-approval is that it gives you a realistic understanding of how much you can borrow. This helps you focus your property search on homes within your price range, saving you time and preventing disappointment.
2. Stronger Position as a Buyer
Having a conditional approval can put you in a stronger position when you're making an offer, showing sellers you're serious and financially capable. In competitive markets, this can give you an edge over buyers who haven't taken this step.
3. Faster Purchase Process
Once you find a property you want to buy, having pre-approval can speed up the final approval process since much of the paperwork and assessment has already been completed.
4. Confidence in Negotiations
Pre-approval gives you the confidence to negotiate with real estate agents and vendors, knowing exactly what your budget limits are.
Limitations of Pre-Approval
While pre-approval is valuable, it's important to understand its limitations:
1. Not a Guarantee
A pre-approval is generally only an indicator of what your lender is willing to lend, and there is no obligation for the lender to hand over that amount! The final approval will depend on various factors, including the property you choose.
2. Property Assessment Not Included
Pre-approval doesn't include a property assessment. The lender will need to evaluate the specific property you want to purchase before giving final approval.
3. Subject to Changes
Your pre-approval may be affected by:
- Changes in your financial situation (new job, additional debt)
- Changes in lender policies
- Fluctuations in interest rates
- Property-specific factors (location, condition)
Do You Need Pre-Approval?
While pre-approval isn't mandatory, it's highly recommended for several reasons:
When Pre-Approval Is Particularly Important:
- For first-time buyers: If you're new to the property market, pre-approval helps you understand your budget and the mortgage process.
- In competitive markets: When properties are selling quickly, having pre-approval can give you the confidence to act decisively.
- For auction purchases: Buying at auction involves committing to buy before having formal approval from your chosen lender. Pre-approval gives you a better understanding of your limits before bidding.
- If your financial situation is complex: Self-employed individuals, contract workers, or those with irregular income can benefit from knowing in advance if they qualify for a loan.
When You Might Skip Pre-Approval:
- Very early in your property search: If you're just starting to explore the market and aren't ready to buy in the next 3-6 months.
- If you've recently been declined: If a lender has recently declined your application, it might be better to address the issues before applying again.
When Should You Apply for Pre-Approval?
Timing is crucial when it comes to pre-approval:
Avoid applying for a pre-approval too early in your home buying journey. This can be risky as pre-approvals have an expiry date, often around 90 days. If you haven't found a property by then, you'll need to reapply and go through the process again, which can affect your credit score.
Ideally, you should apply for pre-approval when:
- You're financially ready to purchase
- You've done your research on the property market
- You plan to buy within the next 2-3 months
- You have a good understanding of the type of property you want
Factors That Can Affect Pre-Approval Duration
Several factors can influence how long it takes to get pre-approval:
A straightforward application could be pre-approved within a day. On average, it's more likely to take 3-5 business days. And if your situation is more complex, it could take up to 2 weeks.
Factors that might extend the timeline include:
- Loan amount: You're borrowing A LOT. As in, more than $2 million.
- Loan-to-Value Ratio (LVR): You're borrowing more than 80% of the property's value. A loan above 80% might call for Lenders Mortgage Insurance (LMI), which takes more time for the lender to process.
- Employment situation: Your employment is unusual or irregular (as in, you've just started a new job or you're on contract work).
- Complex borrowing structures: You're borrowing through a trust, a company, or a self-managed super fund.
What Happens After Pre-Approval?
Once you have your pre-approval, the next steps are:
1. Find a Property That Meets Requirements
A pre-approval is subject to the lender accepting the property, so it's best to check the criteria have been met before making any offers. Examples of the criteria can include the property size, location, or zoning.
2. Engage a Conveyancer
We recommend you engage with a conveyancer (or settlement agent for WA) before making an offer to assist with the legal documents for purchasing the property.
3. Make an Offer or Bid at Auction
With your pre-approval in hand, you can confidently make offers up to your pre-approved amount.
4. Get Building and Pest Inspections
These inspections are crucial for identifying any issues with the property that might affect its value or liveability.
5. Apply for Formal Approval
Once your offer is accepted, you'll need to apply for formal approval by providing the lender with:
- The signed contract of sale
- Property details
- Any additional documents requested in your pre-approval conditions
Tips for a Smooth Pre-Approval Process
- Maintain financial stability: Avoid making significant changes to your financial situation during the pre-approval period.
- Consider using a mortgage broker: A broker can help navigate the pre-approval process and identify lenders most likely to approve your application.
- Be honest about your finances: Providing accurate information will prevent complications later.
- Have all documentation ready: Gather required documentation in advance: To help ensure a smooth and speedy process, have all required documentation readily available, including pay slips, tax returns, bank statements and ID documents.
- Check your credit report: Review your credit report before applying to address any issues.
Final Thoughts: Is Pre-Approval Right for You?
While pre-approval isn't a mandatory step in the home buying process, it offers significant advantages that can make your property journey smoother and more successful.
For most homebuyers, especially in today's competitive market, getting pre-approved is a wise decision that provides clarity, confidence, and a competitive edge. It helps you understand your budget, demonstrates your seriousness to sellers, and streamlines the final approval process when you find your dream home.
Remember that pre-approval is not a guarantee of final approval, but rather a helpful starting point that gives you a clearer picture of your borrowing capacity. By understanding both the benefits and limitations of pre-approval, you can make an informed decision about whether it's the right step for you in your home buying journey.
If you're ready to take the next step toward homeownership, consider reaching out to a mortgage broker or lender to discuss your pre-approval options and start your journey on the right foot.
