Pre-approvals, more important and less concrete than ever
- A mortgage pre-approval is little more than a ratehold.
- A second alternate credit report can be accessed by the lender/insurer and its contents devastating.
- A mortgage pre-approval is not fully underwritten and is not a guarantee of financing.
- A mortgage pre-approval leads some buyers to take steps with a false sense of confidence.
Going through the pre-approval process is more important than ever to both you and your Realtor, but the actual term ‘pre-approval’ is misleading.
You may well be pre-approved for a certain mortgage amount, however there are still a number of variables that can enter the picture once an offer is accepted, therefore it is imperative that one always include a clause in the offer along the lines of ‘subject to receiving and approving financing’. (There are variations to be discussed around the specific wording.) The mortgage amount is one thing, the actual approval including the property is another.
Often clients are reluctant to write the initial offer on a property without feeling like they are 100% pre-approved.
An understandable desire. The misunderstanding in this is that there is no 100% until the property is selected. Too many clients falsely believe that they have a guarantee of financing. They do not. That is not at all what a pre-approval is.
A lender must review all related documents – not just those of the clients, also those from the appraiser and the Realtor – as the property itself must meet certain standards and guidelines.
The pre-approval process should be considered pre-screening only.
It does involve review and analysis of the client’s current credit report; it should also include a detailed list of all documents that will be required in the event that an offer is written and accepted. You should also come away from this initial process with a clear understanding of the maximum mortgage amount you qualify for, along with the various related costs involved in the specific real estate transaction. Equally important: with the completed application your broker is able to lock in rates for up to 120 days.
Why won’t a lender fully review and underwrite a pre-approval?
- Lenders do not have the staff resources to review ‘maybe’ applications – they have a hard enough time keeping up with ‘live’ transactions.
- The job you have today may well not be the job you have by the time you write your offer, thus verification of employment is delayed.
- If more than four weeks pass, all of the documents are stale dated – by lender standards – and a fresh batch needs to be ordered and reviewed.
- The conversion rate of pre-approvals to ‘live transactions’ is less than 10%. Imagine working for ten days and being paid only for one.
It is this last point that makes it so difficult to get an underwriter to completely review a pre-approval application as a special exception. Although it can still be done on a very limited basis.
A new twist
In the case of a client purchasing with less than 20% down a pre-approval is weaker still. With less than 20% down there is a mortgage insurance requirement and additional underwriting by CMHC, Genworth or Canada Guaranty is required. Now we are trying to please not only the underwriter working for the lender, but also the underwriter working for the insurer. All too often the insurer will access a second, alternate, credit report from TransUnion.
Often this report, not accessible during a pre-approval, will reveal an entirely new skeleton (or three) in the closet. That $73.00 cell phone bill you ‘disputed’ by simply not paying it, the $42.00 department store credit card annual renewal fee that you ignored, the out of province parking tickets from 6 years ago…such trivial sounding items can in fact cost you the opportunity to qualify to buy. Such things coming out of left field following ‘pre-approval’ is frustrating for all parties involved in the process. Without full disclosure by the client these issues simply do not arise until an actual purchase contract has been submitted, as the insurers will not review a pre-approval at all.
This plays heavily into why writing a subject free offer is especially daunting for a client with less than 20% down. Overcoming obstacles with one underwriter is one thing, overcoming them with two underwriters is another.
The bottom line is that a client’s best bet for confidence is the educated and experienced opinion of the front-line individual with whom they are directly speaking. And that’s their Mortgage Broker, even though this individual will not be the same person who underwrites and formally approves the live transaction when the time comes.
This disconnect between intake of application (pre-approval) and actual underwriting of a live file makes having a ‘subject to receiving and approving financing’ clause in the purchase sale agreement so very important.
Perhaps the most significant factor in undermining the solidity of a client’s pre-approval is the relentless pace of change in lending guidelines and policies – change implemented not only by the Federal Government but also by the lenders themselves. It is all too common to have a pre-approval for a certain mortgage amount rendered meaningless just a few days later through changes to internal underwriting guidelines. Often these changes arrive with no warning and pre-existing pre-approvals are not grandfathered.
Proceeding with the pre-approval process remains essential prior to writing offers, and in particular before listing your current property for sale or accepting offers, as it will give you a good idea of your maximum mortgage amount as well as securing a rate for you. It is a worthwhile endeavor, it does not put one in the position of strength that they might expect though.
As excellent as a pre-approval conversation is for screening out the big issues and addressing them in advance, a pre-approval is not a 100% guarantee of financing.