Obtaining a mortgage can be one of the most confusing parts of buying a home. It’s essential to understand the steps along the way to getting a home loan and the key terms that are used by lenders. Pre-approval and approval are two different stages that essentially come at opposite ends of the process.
Mortgage pre-approval vs. approval: What’s the difference and why are they important?
During the pre-approval process, the lender is looking at you as an individual, as a couple, whoever is seeking financial assistance for buying a home. They are reviewing your credit, your income, your assets, and any debts you may owe.
Final approval consists of approving you, as the buyer, and now the property as well. The lender is looking to see if the property is ideal and if it makes sense for them to loan the money to purchase it. The bank won’t lend money to a property if they feel the value is not there and they won’t recoup their costs in a worst-case scenario.
If I’m pre-approved and my property is ideal, do I automatically get final approval?
There are some situations where you get pre-approved, you find the perfect property, the property is approved, but you don’t get final approval because it’s subject to mortgage insurance approval. When you're putting less than 20% down, it has to go through the final approval process twice - one will be with the bank, and the next one will be the mortgage insurance provider.
The reason why their approval is so important is because they're actually providing insurance on the amount that's borrowed from the bank. The bank will look at the pre-approval, you find the property, and then the bank sends it to the insurer for an approval. Upon reviewing, they may approve or they may decide the loan deal needs to be restructured. If it needs to be restructured, this can be done in a variety of ways including more money towards the down payment, paying off debts owed, or adding a cosigner to the loan agreement.
What happens if the bank doesn’t find the property I want to purchase ideal?
In most cases, when the lender doesn’t like the property, the homebuyer stays with the lender and finds another property. Lenders may not approve a property because they don’t feel the selling price matches the actual value, they may feel there’s unforeseen health hazards, etc. For a bank to not like a property, it has to be significant. If the bank were to provide information or proof that there were legitimate concerns about a property, it typically deters the buyer away. It’s your investment as well, not just the bank's. In very seldom scenarios will clients absolutely love a house and don't agree with the bank's reasoning.
Can you switch lenders after pre-approval?
Absolutely. A pre-approval is tied to you as a buyer, it's not attached to a property. You can even switch lenders for final approval. Let's say you're building a brand-new home and your build process is taking 10 months. You struggle with your bank and then you realize later on the rates are not the best with this particular lender. You don't like the terms and conditions, but you haven't signed anything yet. You can switch your approval within that 10-month period. You are not locked in until the bank actually lends out money for the transaction to be closed.
Does your pre-approval affect your credit score?
Your pre-approval is not going to affect your credit score if you only do one or two. If you're going to do 10 different pre-approvals, you're going to do 10 different credit checks, and it’s going to be a red flag for the credit bureau. The credit bureau's thinking, "Why is a client going to a sixth bank if they got approved with the first five?" A credit score is a risk score for an individual and that’s what the bank is looking at. It is a way for lenders to assess your risk by reviewing a variety of criteria:
All of those criteria are calculated and you are assessed a risk value – your credit score. It’s better to use caution and research lenders before beginning pre-approval application with each bank. Find out what their rates are, what their terms and conditions are, narrow it down to one or two that make sense for you and then do the formal application.
To be clear, you don’t need to obtain a mortgage pre-approval in order to start shopping for a home. A real estate professional will be happy to start showing you homes and submit offers on your behalf without a pre-approval in your hand.
However, obtaining a pre-approval is a smart idea for two main reasons. First, it lets you know beyond any reasonable doubt that you’ll be able to obtain a mortgage and the specific amount you’ll be able to borrow based on your actual financial situation. Second, a pre-approval shows sellers that you are a serious buyer and will be able to close on the home at the price you’ve agreed to pay. So, while you don’t need to have one, it’s definitely a good idea to get pre-approved before you submit your first offer on a home.
Find more resources and information at Brookfield Residential’s Homebuyer School to better understand the entire home buying process and make the best decisions when purchasing your next home.