Regardless of whether you are a first home buyer or a seasoned property investor – Obtaining a pre-approval should always be part of your first steps when embarking on a property purchase journey.
What is a “Pre-Approval”
A pre-approval: (Also known as a “conditional approval,” “indicative approval,” or “approval in principle”) Refers to an initial assessment from a lender whereby they agree, in principle only, to lend a certain amount of money to an applicant prior to the actual purchase of a property.
There are technically TWO kinds of pre-approvals:
1. Fully assessed
2. System-generated
A “fully-assessed” pre-approval; typically involves a lender’s credit performing a full assessment of your personal circumstances, including a) an assessment of your income, expenses, assets, and liabilities, and b) an assessment of your file against the bank’s credit policy. By performing a more in-depth assessment of both your financial circumstances and your application’s eligibility against the bank’s policies, these approvals are usually seen as more “solid” in the eyes of mortgage brokers and financial advisors.
A “system-generated” pre-approval; typically involves submitting an online application, which is then run through an automated assessment program. Whilst a system-generated pre-approval can often be obtained much faster than a “fully-assessed” pre-approval, typically a system-generated pre-approval will only look at a single metric when evaluating your borrowing capacity vs. the loan amount you have applied for. By only looking at a single financial metric, system-generated pre-approvals can sometimes ignore to look at the “real-world” specifics of your scenario, and whether these actually align with the bank’s credit policies. For this reason, system-generated approvals can be considered higher risk for more complex scenarios.
To ensure you are attending an auction with comfort that a lender is going to support you, it is important to have the conversation with your bank or broker, as to whether your approval will be fully assessed, or system generated.
Why Do You Need One?
By presenting the bank with an overview of your financial circumstances (income, liabilities, assets, and expenses), as well as an overview of the indicative property you intend to purchase – A pre-approval thus stands as an indication that a bank has assessed your circumstances, is satisfied you meet their credit criteria, and has found that you could service a loan up to the pre-approved loan limit they have signed-off on the pre-approval.
Obtaining a pre-approval accomplishes THREE primary things:
1. Firstly, it establishes the maximum amount of money that a lender is willing to lend you. Knowing your borrowing power automatically helps you narrow down your search to options that fall within your pre-approved price range.
2. Secondly, if your pre-approval is fully assessed, it also acts as a signal that a bank has evaluated, flagged, and/or rectified any potential issues that may be associated with your application, reducing the likelihood of any nasty surprises further down the line.
3. Lastly, a pre-approval can serve to “lock-in” a bank’s credit policies, and assessment criteria – Providing you with a grace period of ~ 90 days. During this time, you can be comfortable knowing that you have secured your required level of funding with the bank, regardless of whether interest rates rise or not.
Are You Truly Covered?
Important to note is that pre-approvals only serve as indications from a lender that they are willing to assess your loan when you lodge a full application. The lender is under no obligation to formally approve your loan and is entitled to perform a full and/or new assessment when you find and purchase a property.
With recent changes in interest rates, and the market seeing an unprecedented period of volatility – Some banks have inserted clauses allowing them to reassess pre-approvals in certain circumstances.
That is, where a borrower used to have their borrowing capacity “locked-in” by a pre-approval, protecting them for a ~90-day period against the impacts of any interest / assessment rate changes, they may now be susceptible to a reduction in their borrowing capacity, as banks are increasingly reserving the right to reassess their pre-approvals following interest rate movements.
As an example, a 0.50% rise in interest rates can lower your borrowing capacity by up to 5.00%. With interest rates having moved ~ 1.50% over the 3-month period spanning 8 Jun 2022 – 3 Aug 2022, a pre-approval of $1,000,000 in June may translate to $850,000 in August should a bank reserve the right to reassess the file.
In Conclusion
Whilst a fully assessed pre-approval can offer more surety than a system-generated one, it is important to note that all pre-approvals will come with a set of conditions for formal approval, and that they are in no way guarantees of finance or the provision of lending.
Some people choose not to get a pre-approval and, in doing so, are taking a risk as they have no indication that they will be approved for a loan or obtain the finance necessary to complete their settlement.
A mortgage broker can help you source and obtain the correct pre-approval to match your personal circumstances. They can guide you through the application process and educate you on what you need to know about certain bank’s policies, timelines, assessment criteria and pre-approval conditions.
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As always, feel free to reach out to me or one of the team at Smartmove Professional Mortgage Advisors for any mortgage or finance advice questions/ needs.
Written by Asher Levitt
With a passion for the property, real estate and financial services sectors, my career saw me working as a Business Analyst for multiple firms before joining Smartmove as a Mortgage & Finance Advisor in 2020. With a range of experience in both Accounting and Property Finance, I look forward to bringing this varied experience to help clients achieve their property and finance goals.
