A pre-approval refers to a lender’s commitment to offer a mortgage to a borrower before the borrower has purchased a property.
Pre-approval should not be confused with qualification.
The main difference between the two are that for a pre-approved loan, a home loan is guaranteed, while a pre-qualified loan has no guarantee.
This is because a lender will have gone through the process of credit evaluation and underwriting after a borrower has submitted proper documentation in order to finally grant a pre-approved mortgage.
This is not the case with a qualified mortgage.
Sometimes also called an in-principle approval, there are various advantages for borrowers to obtain pre-approvals before seeking to buy or buying a house.
Some of which include:
- Greater bargaining power
- Narrow down home searches within the budget
- Buying with confidence that financing is ready
- etc
How approvals look like
It goes without saying that there is no way a lender will inform a borrower about the pre-approval without mentioning the amount that is granted.
Otherwise, just a yes answer might tempt a home buyer to buy a million dollar house when he can only afford a $200,000 one.
So approvals can be presented in a few way.
The first way is an expression of the monthly mortgage payment amount that the borrower is approved for.
For example, it might be $1,000 a month.
This means that no matter what price a borrower ends up buying a house for, the limit of the mortgage amount will be within the bounds of only $1,000 a month for the home loan.
A second method is to inform the applicant of a maximum loan amount, subject to loan to value requirements.
For example, an approval might look like: $300,000 approved for up to 80% LTV.
This means that the maximum price of a house the home buyer can buy will be $375,000, with $75,000 down payment and $300,000 loan.
Should the buyer purchase a home at $400,000, the maximum home loan amount will still be restricted to $300,000 as this figure is the amount the lender determines that the borrower can afford.
Should the buyer purchase a house at a lower price of $250,000, the maximum loan will then be $200,000 as it is subject to 80% LTV.
This assumes that the purchase price is equal to property value.
A third way is by offering a lower loan quantum, but can go higher provided certain conditions are met.
For example, borrower might be approved for $150,000. But the lender will be willing to go up to $180,000 if the borrower pays off the existing debt on his auto loan.
This can sometimes work in the favor of the borrower as outstanding balance on the car loan is only a few month’s worth of payments.
In this case, documentation verifying the settlement of the car loan will be required together with the sale and purchase agreement when a house is eventually bought.
Whatever your situation, it is recommended that any home buyer should obtain a pre-approved loan before buying a house to prevent any unexpected shocks with financing.
It can be a costly mistake when luck is not on your side.