Pre-Approval, Approval, and Pre-Qualification Process
When starting the mortgage process with a new client, I’m usually asked to provide a Pre-Approval for their upcoming purchase. What these new clients usually do not know is that the Pre-Approval document provided by banks is the easiest document to get, yet the least reliable to have.
What is a Pre-Approval?
A Pre-Approval is usually a one-page document that acts like a 90- or 120-day rate hold, its term depending on the bank. It shows the rate, the client’s name, the projected monthly payment, the length of the mortgage contract, and the life span of the loan, also called the amortization. The Pre-Approval also includes information about the maximum purchase amount a client can go for, and while we have seen many clients rely on this piece of information, it is often a misleading number.
Since the Pre-Approval is automatically produced according to verbal information given by the client, not information supported by documents, it has the huge potential to be void. For instance, if the clients say their household salary is 120K, but didn’t discuss their salary structure with the bank, they might shortly discover that the bank actually considers their salary to be 50K, reducing their ability to borrow to less than half!
Then Why Get A Pre-Approval? The Advantages and Disadvantages of a Pre-Approval
The big advantage in getting a Pre-Approval is having a rate hold. However, since the personal information and supporting documents of clients are not verified at the time of the Pre-Approval, there is a chance that the information in the Pre-Approval will change, leaving the client with a reduced purchase amount.
An example using the previous scenario: in that family, one of the partners earns 70K and is self-employed for less than two taxable years, meaning their income might not be recognized at all. This is how a 120k household income can drop to 50K. Another example is if the same partner showed a good income last year, but their previous year was much lower, the lender will use an average, reducing the borrowing power significantly.
This can also apply to part-time jobs. If our prospect client works two part-time positions, they might not be recognized at all if two consecutive taxable years cannot be shown in each position. These are a few scenarios where a Pre-Approval loses its validity, although there are many more.
Additionally, banks rarely check the down payment during the Pre-Approval stage which means that they might void the application in a later stage if there is difficulty showing that the down payment comes from the client’s own resources, or if the bank account shows incoming deposits that cannot be explained.
Further, since the Pre-Approval relies on clients’ verbal communication and personal information, it does not refer at all to the property’s features. We have seen applications declined because of various reasons, such as when the insurer and lender did not want to mortgage the building, or the condo fees were too high and shifted the numbers, etc.
The bottom line: although clients feel protected by having a Pre-Approval, they should be aware that it does not protect them at all – it may even put them at risk if they rely on it and put a subject-free offer.
In our next blog, we will delve into the Approval and pre-qualification process that address the common challenges that arise in the Pre-Approval process.