What is home loan pre-approval?

If you want to get into your dream home sooner, applying for home loan pre-approval might be worth having at the top of your 'to-do' list.

On the home buying journey, getting home loan pre-approval can be a crucial step that gives you a better idea of your financial position and provides approval in principle for a home loan so you can get serious about house hunting.

Managing director of financial advice business the MoneySmith Group, Paul Cluff, said you’ll want to balance all your needs against what you can afford when you start searching for the perfect home.

“A good move is to get pre-approval – also known as conditional approval or approval in principle – for a loan. With your financial position in mind, you can then set about contacting real estate agents or researching houses online,” Mr Cluff said.

It’s important to know that pre-approval is not unconditional or final approval. The lender is under no obligation to give you the money and you’re under no obligation to take the loan.

Home loan pre-approval is usually the first stage of a lender approving you for a loan amount. It lets you move forward with some confidence about how much money you have to spend on your dream home.

However, while it’s common to get pre-approved so you have peace of mind and a clear indication of how much you can borrow, sometimes the lender may, later, decide against ‘formally approving’ your application, says Mr Cluff.

“This can happen for several reasons including the lender changing their own lending policy between when the home buyer was pre-approved and the actual time when they’re buying the property, for example,” he said.

As the home buyer, your circumstances may also change – say you lose your job, split up with your partner with whom you were going to buy the home or investment property, or fall seriously ill.

These circumstances would all affect your financial situation and your ability to repay the loan amount and, consequently, buy a home.

Other reasons that pre-approval may not turn into final approval include your dream home not coming up to valuation, or being in a condition that the lender does not think is resaleable should you default on the loan.

A change in interest rates may also cause the lender to review your ability to repay the loan and, hence, the loan amount that they may finally sign off on.

“To minimise the chance of a refusal of final approval, a mortgage broker can run your personal financial scenario against multiple lenders, so they can give you a good indication of how to proceed,” Mr Cluff said. “That way, you will have different lenders to choose from and a clearer indication of how much you can borrow.”

It’s not compulsory. You may decide you want to start your home buying journey by searching for your dream home on the property market, and then applying for a loan.

The problem with this scenario is you may not really know how much money you can spend to buy a home or an investment property until a lender takes a good look at your financial situation.

Think of it this way. You decide you’re going to buy a new car, but you have no real idea of how much you have to spend. So, you look at expensive four-wheel drives or sleek sports cars and then, when you apply for a personal loan it turns out that your budget will only stretch to a medium range sedan.

If you want to be taken seriously by real estate agents, and vendors in the market in which you want to buy a home, having a maximum spend and loan amount in mind makes sense.

Another argument for applying for pre-approval for a home loan is that, having done a lot of the legwork, you may be able to beat other buyers to the draw in a competitive market. You’re ready to make an offer and, hopefully, the lender is ready to green light it.

Of course, if you’re going to auction, where the sale is unconditional from the moment you are the winning bid, pre-approval becomes even more important. Imagine bidding $1 million for a home or investment property and then finding out you can only borrow $700,000!

As soon as home buyers are ready to start looking at properties seriously, they can apply for pre-approval. Naturally, you should have saved as much as you can for a home deposit.

You can approach a mortgage broker, who will deal with the process for you, or you can go directly to the loans officer at your bank or credit union. You can also apply in person, or apply online. But you will need to have all the paperwork that relates to your financial situation in order.

“Lenders will take several factors into consideration to determine your borrowing potential while also ensuring you can afford the regular repayments towards your loan,” Mr Cluff said.

They may look at evidence of:

• Your income
• Your household expenses
• Assets you own
• Debts you owe
• Number of dependents
• Other financial obligations you have
• Limits on your credit card.

Whether you intend to be an owner occupier, or you’re buying an investment property, the lender will conduct a credit check to see how you stack up as a risk. You can get your own credit report from a credit reporting body such as Experian or Equifax, or check your credit score using free online tools, if you want to see how you rate.

“Your pre-approval is valid up to three months and provides a reasonable time to begin your house hunting process,” Mr Cluff said.

By the way, pre-approval doesn’t cost anything but that doesn’t mean you should apply multiple times, as this could potentially affect your credit rating negatively. Consider applying just before you start the home buying process.

Pre-approval does have the potential to:

• Give home buyers a good idea of their budget
• Improve your chances of looking like a serious buyer to vendors and real estate agents
• Speed up the home buying process
• Give you an edge over a home buyer who doesn’t have pre-approval
• Encourage you to get all your paperwork organised before you getting too excited.

Pre-approval doesn’t:

• Guarantee the bank will lend you the money
• Mean you don’t have to have a credit check
• Ensure you are the highest bidder on your dream home