Pre-approvals – what are they and who should get one?
What is a pre-approval?
One of the most critical steps when seeking finance to purchase a home or investment property is a pre-approval. Getting a pre-approval means that a lender has conditionally approved to lend you a certain amount of money to secure a property. Usually a pre-approval will last 3-6 months, but it can also be rolled over as needed.
What are the benefits of a pre-approval?
A pre-approval enables you to narrow your property search as you’ll know the maximum amount you can spend on a property. It allows you to have more intent and focus, and creates more certainty so you can adjust your search accordingly. It avoids aimless searching or wasting time speculating about what you should be able to afford without knowing for sure. It also means you can start putting in offers or bid at auctions without the risk of overestimating what you can afford, while giving sellers the confidence that you’re serious.
While technically a pre-approval isn’t always a necessary step in the process of purchasing a property, it’s generally recommended as a way to give you clarity and speed up the process once you do seek formal approval. A lot of the due diligence is done in advance of a property’s settlement, reducing the risk for settlement delays as a result of a lender.
What’s involved in the pre-approval process?
The pre-approval process involves disclosing to the lender your financial situation including:
- Your assets – This will include any properties, vehicles, shares, businesses or other assets that you own
- Your debts – This will include any home loan, credit card, car loan, personal loan or other debt
- Your income – This will include your wages, salary, rental income, bonuses, director fees, commissions or other income
- Your spending – This will include your expenses such as rent, food, utility bills as well as discretionary spending on travel, entertainment and more. Up until recently, lenders were scrutinising spending in bank statements line by line, but this has become less common in the last 6 months as people are generally spending less during the pandemic overall
The lender will usually perform a credit check with a third party. They may also want to know about the kind of property you want to purchase and where it will most likely be located.
A good broker will guide you through the pre-approval application process to ensure you put your best foot forward.
Are there any risks to consider?
While there will always be some risks in any property purchase, working with a good broker can reduce the risks drastically. While it’s important to remember that pre-approval isn’t a done deal and the bank technically doesn’t need to honour it, generally there are only a few rare scenarios where this could occur:
- Your financial circumstances have changed since you were granted pre-approval. This includes losing your job, a change in income, or you’ve moved into self-employment. Generally the banks like to see 2 years of financials for self employed borrowers (minimum 1 year for some lenders) before considering a self employed application.
- The bank valuation for the property you want to purchase is significantly below what you’ve agreed to pay for it. It’s rare for this to stop a purchase, as it’s more common for small discrepancies to occur, which a good broker can often mitigate by negotiating with a different bank.
- The bank applies a postcode restriction, preventing you from seeking finance with them for a property in that postcode. Usually this means they already have a large number of loans on properties in that area and therefore feel overexposed should that market decline. This happens rarely and typically applies to postcodes with significantly new property supply. Experienced brokers are aware of lender postcode restrictions, so the only risk is if the restriction is introduced just as you move to purchase. A good broker will be able to quickly pivot to another bank should this issue arise.
Should you take out a pre-approval for an off-the-plan purchase?
An off-the-plan purchase involves the purchase of a new property, either under construction or yet to start construction. Buyers will typically wait anywhere from 12-48 months for the construction to be completed.
In this case, your pre-approval will expire early on in the process and will not be valid at the time of settlement. This isn’t a problem, so long as you have confidence that your financial situation will be the same or better when the property is complete, enabling you to obtain an approval. About three months out from settlement, when the building is close to completion, borrowers should consider applying for formal approval with a preferred lender.
Most borrowers will not bother to obtain pre-approval for an off-the-plan purchase as it will simply expire. If however, the broker or borrower is concerned about their ability to borrow funds under today’s lending conditions, then it might be prudent to apply for a pre-approval just so the borrower has the confidence the bank is willing to support them under today’s circumstances.
This could be prudent for borrowers in specific situations, such as those with a troubled credit history or borrowers with less than 20 years until retirement age.
If you’re considering getting a pre-approval, it’s best not to delay. Starting the conversation sooner rather than later will bring you closer to purchasing a property and avoid you missing out. There’s no risk with the lender should you seek a pre-approval without immediately making a purchase. In fact, some people will roll their pre-approval over for up to 12 months. The greater risk is not being prepared to make a purchase when the right opportunity arises, especially if the market is competitive. Seeking pre-approval removes a lot of the risks.
If you’re interested in seeking a pre-approval or want to learn more, talk to the team at Orium Finance today to discuss your options.
Orium Finance is open for business remotely during the NSW lockdowns. We are cloud-based, allowing us to continue operating as usual, including meeting with you virtually via Zoom and undertaking signatures for documents electronically when possible. Get in touch with us today to discuss your lending needs.
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