Everything you need to know about pre-approvals
A pre-approval is an important part of the mortgage journey. This article is based on our recent webinar all-about mortgage pre-approvals. We looked at the Five C’s of Credit, collateral, terms & conditions, the purpose of a pre-approval, and what a pre-approval is not. Read on to learn more about each of these valuable points.
The last of the 5 C’s of Credit represents the specific property you will purchase. The property cannot be covered during the pre-approval, because you have not identified a specific property yet. Even if you have a specific property in mind, mortgage lenders will only underwrite a final mortgage application, and thus the property, upon receipt of a fully executed purchase & sale agreement. Thus, the collateral can only be covered conceptually and anecdotally during the pre-approval stage of the mortgage process.
The full coverage of the Collateral part of the 5 Cs of credit typically involves these points:
- Mortgage rules affecting the financing of the property
- The geographical location of the property
- The property’s purchase price versus the lender’s appraised value
- Market conditions in the area
- Marketability of the property
- How the property is perceived by the lender
- If it is a condo, the status certificate
- Condition of the property. This is usually covered by a property inspection
- Unacceptable property flaws. For example, kitec plumbing
- Environmental issues with the property and/or the area
- For rural properties, the sewage, water source, and water flow rate to name a few
The terms & conditions of the final mortgage:
Lenders will start evaluating a final mortgage application only upon the receipt of a fully executed purchase & sale agreement. Upon the successful evaluation of the application, the lender will issue a conditional mortgage approval. A conditional approval means the mortgage is approved subject to you successfully fulfilling every mortgage condition at least 10 banking days before your mortgage’s closing date. Pre-approvals cannot cover the terms and neither the conditions of the final mortgage thoroughly which exposes you to substantial risks.
Some of the conditions associated with a mortgage approval and typically not covered by a pre-approval are:
- The property itself
- Income documentation and verification
- Down-payment documentation and verification
Since pre-approvals don’t cover the property and neither the mortgage’s terms & conditions, borrowers have to find a way to protect themselves against risk and potential loss. To find out how you can protect yourself, let’s determine what a pre-approval is, and what it is not.
What to Expect During the Pre-approval Process?
For your mortgage broker to successfully complete a comprehensive pre-approval s/he should cover the 5 Cs of Credit by at least doing the following:
- Understanding your needs
- Taking an application from you
- Checking your credit
- Request from you, up-front, a complete set of mortgage support documents. E.g. Income, down-payment, photo IDs, etc.
- Upon receipt of your support documents and checking your credit, complete a comprehensive mortgage analysis for you
- Meet with you to review your mortgage analysis
- If possible, issue you with a pre-qualification letter
The Purpose of a Pre-approval:
It is important to note that not all mortgages can be pre-approved, especially alternate mortgages, rental property mortgages, and mortgages where the applicants’ income cannot be verified traditionally, for example, because of the non-standard underwriting criteria for such mortgages.
The primary purposes of completing a pre-approval prior to starting the purchase process are:
Establish your maximum purchase price.
Get educated about the mortgage market and marketplace, your credit, mortgage risks, rules, eligibility, products, and the mortgage process. The mortgage market has changed significantly over the past 10 years and is continually changing, so it is best to avoid assumptions.
Gather budget data so you can be sure to afford your mortgage, not just qualify for it.
Evaluate your mortgage broker/financial institution’s rep’s skills and values to see if they are capable, their vales match yours, they have your best interests at heart and whether you would like to work with them.
As much as possible cover the 4 Cs of Credit before you purchase to minimize any nasty surprises.
Understand the mortgage process to make your purchase as peaceful as possible and to avoid unintentional risks and losses.
It can be a rate-hold, however, pre-approval rate holds are usually higher than the actual rates available in the marketplace.
A good realtor would want you to be pre-approved and equipped before you start looking at properties.
What a Pre-approval is not:
Pre-approvals are often misunderstood to be a mortgage approval before (pre) purchasing a home. While this would be ideal and desirable, as previously explained a mortgage approval without a property is impossible. While a pre-approval/pre-qualification is essential and helpful, it is not a mortgage approval and you should protect yourself against a potential mortgage application decline.
Here are a few additional reasons why a pre-approval is not a mortgage approval:
Most pre-approvals are auto generated by a system and are not underwritten, which means the lender does not review nor verify your supporting documents, etc.
If a pre-approval is underwritten, in the absence of a property it is underwritten against partial or incomplete underwriting guidelines.
If your mortgage is insured or back-insured the mortgage insurer does not evaluate your pre-approval, only the lender.
They don’t cover all eventualities such as bridge financing, etc.
The pre-approval is subject to the lender’s final approval and terms and conditions.
Since your pre-approval does not protect you, secure for yourself the opportunity to exit the purchase process without cost if your mortgage application is declined or you don’t like your mortgage terms and conditions.
One of the ways you can protect yourself is by inserting a comprehensive Condition of Finance (COF) in your purchase & sale agreement. At its minimum, the COF should allow you to exit the purchase process without cost if your mortgage cannot be approved or you cannot obtain satisfactory mortgage financing before the COF expiry date. For a COF to be effective your COF period must be long enough to get a mortgage approval, allow you to fulfil at least your primary mortgage conditions and give you enough time to review and sign your mortgage documents.
Borrowers have intentionally been taught that having a mortgage approval document is sufficient to protect themselves and sufficient ground upon which to waive their COF, however, this is not enough since the mortgage is only conditionally approved until all the conditions are considered fulfilled by the mortgage lender.
If you have allowed enough time for your COF, you should insist that at least the following actions are completed by your financial institution or mortgage broker during the COF period and prior to the COF expiry date:
- Your mortgage is approved in writing
- The appraisal is ordered, completed and approved by the mortgage lender
- Your primary mortgage conditions are fulfilled. For example, income, down payment, etc.
- You have reviewed and accepted your mortgage details and terms.
- Give you enough time to sign the mortgage documents
By watching the webinar recording and reading this article, we hope you were able to get a good start at understanding the basics of a mortgage pre-approval. Should you have any comments or questions, please feel free to contact us. We look forward to helping you get pre-approved!