Mortgage Pre-Approval No Guarantee
Author: Tracy Ruddell
You’re a first-time buyer looking at condos or houses for sale in Toronto. You’ve done all the right things including saving for a down payment, researching the market, crunching your budget, hiring a skilled REALTOR® and getting pre-approved for a mortgage. You decide to make an offer on a property under the maximum amount you’ve been pre-approved for. You’re safe to make a firm offer, right? Not necessarily.
In today’s hot Toronto Real Estate market, despite the pressure to make a firm offer to win a bidding war, you run the risk of not being able to close on the deal even with mortgage pre-approval. Prospective home buyers need to know the facts before offer night; that's why we're publishing a two-part special on mortgage approval to arm our readers with the information they need to make informed buying decisions.
Buyers often mistake mortgage pre-approval for a guarantee. It’s like the difference between a letter of intent and a signed contract – the former being an indication of the likely outcome but not a legally-binding guarantee, as is the latter.
Pre-approval is just a preliminary review of your finances and credit history to suggest what you should be qualified to borrow, providing that nothing changes between the date of pre-approval and closing day. It also assumes that nothing new is found in a deeper dive into your finances. This is why it’s so critical to be honest with your lender from the get go and not hide anything in terms of your employment situation, income, debt or financial stability because it will almost certainly be found out during the actual mortgage application process.
It's important to note though that not all lenders have the same pre-approval terms. Read the disclaimers carefully on your pre-approval letter; if you’re using a Broker, they can help you decipher. Pre-approval by some lenders is a little more concrete than others but you should know that it is almost never a firm offer nor is it a guarantee to lend you any money at all, regardless of the amount.
The big issue here is that buyers (and a heck of a lot of agents, frankly) don't understand the difference between getting pre-approved for a mortgage versus getting pre-qualified for a mortgage. To make matters worse, there's a lot of misinformation on the internet and the terms are often used differently in the U.S. versus Canada - even within our own country different lenders use different terms - which adds to consumer confusion.
No one really talks about "pre-qualification"; you're far more likely to hear people recommend that you get "pre-approval" and this, frankly, is bad (or mis-informed) advice. You may also read in some sources (even Real Estate sites here in Canada) that pre-qualification is a first step, followed by pre-approval, suggesting that pre-qualification is a preliminary review of potential mortgage clients and pre-approval is more in-depth, therefore "better".
We spoke with James Harrison, President of mortgages.ca, to set the record straight. James tells us that::
"It's actually the exact opposite. What you want is to get pre-qualified. What I recommend to all clients is that they get pre-qualified and not simply pre-approved for a mortgage. When I say "pre-qualified" (and the term does need clarification because "pre-approval" is often wrongly used in its stead), I mean that they have provided a Mortgage Broker or Banker with a full package of documents for review. This means that the Broker has fully completed the mortgage application process and reviewed all income documents, checked their client's credit reports and given them full clearance.
Sometimes at the branch-level or when you're just having a quick conversation with a Banker or Broker, they're merely asking you the basics... what is your income (verbally) and what is your credit like? Based on what you are saying or a very preliminary review of your documents, you may get pre-approved but this is not a guarantee that you'll get mortgaged for the amount that you're requesting or, in deed, at all."
As REALTORS®, we've seen this happen one too many times. It's not unheard of that a buyer will win an aggressive bidding war on a home, going in firm to do so (thinking that they have mortgage approval) when all they have is pre-approval and then the deal falls through, losing them their deposit - possibly more.
James goes on to tell us that:
"I have seen countless examples of buyers who had been "pre-approved" at their branch with a form letter that's riddled with clauses that favour the lender, only to find out that they don't qualify for the mortgage in the end. This can be down to small things that they may not even think of at time of application, such as a credit issue they forgot about. If, however, all of your income docs are reviewed up-front, this should never happen.
It's very important for Brokers to collect all documents up-front these days - particularly given the added, financial stress tests that kicked in on Nov. 30, 2016 with Canada's new mortgage rules - so that the client is fully pre-qualified. This will ensure that there aren't any surprises in terms of income or credit that could negatively impact their client's ability to get mortgaged."
We want to caution you however that not all lenders use the terms pre-approval and pre-qualified in the same way. As an applicant, always make sure that you ask the lender or broker what the difference is (as some brokers may use different language) and confirm that you are going through the stricter application process which, although it's a pain in the butt to apply sometimes, will afford you greater certainty. You want to be able to bid on a home with confidence.
In this competitive market, there's a catch-22: you have to give more to get a home (more money, more attractive offer with few if any clauses) but it takes more to get qualified for a mortgage (the added financial stress tests James was alluding to).
As such, we recommend that every first-time buyer gets pre-qualified before they even set foot in their first property for viewing. Pre-approval alone leaves some buyers on shaky ground. In addition, any homeowner who requires an increase in their mortgage amount (i.e. they’re not just porting their existing mortgage) should get pre-qualified before making an offer.
The bottom line is, how can you shop for a new home without knowing what your budget is and how can you make a strong, competitive offer without knowing the risk is involved? Remember, what you think you can afford is not necessarily what a lender will approve you for. Without this, many buyers over-estimate both their borrowing ability (i.e. how attractive of a prospect they are for a loan) and their borrowing capacity (how much they can borrow). In fact, most buyers don’t even know their personal credit scores.
If this sounds like you, don’t feel bad – most people don’t. You’ll find out how attractive a candidate you are for a mortgage loan during the pre-approval process which includes a look at your credit history. However, if you have any concerns and would like to know your credit score in advance of applying, it’s an easy process. You can have your credit score report generated through Equifax or TransUnion.
On the other side of the spectrum, we find that a lot of first-time buyers actually under-estimate how much home they can afford; another reason why getting pre-qualified is so important.
While we never advise that any client over-leverages themselves beyond a comfortable carrying level (even if you’re anticipating a promotion or injection of funds from another source in the near future), it is advisable to buy as much home as you can comfortably afford. In our experience, first-time buyers are far more likely to buy too little property than too much, having to sell just a few years down the road because the space feels too small or won’t accommodate a changing lifestyle (e.g. they’ve moved in with someone or had a baby). Selling too soon can cost you, particularly if you’ve over-paid on the property at the outset which happens far to often in cases of emotional and competitive bidding.
The other reason why pre-qualification is so critical is that sellers will take you much more seriously as a safe-bet buyer. One of the most common reasons why home sales fail to close is lack of financing. In a multiple-bid situation, if you’re the highest bidder but have a "conditional upon financing" clause, a seller may sell to the second bidder if their offer is more secure, particularly if the price difference is only a few thousand dollars.
Getting pre-qualified will also speed up the approval process when the time comes to firm up your mortgage loan.
Applying for pre-qualification does take up a bit of your time. There’s a fair amount of paperwork and digging up of your personal files when buying a home and it can be a daunting process, particularly for first-time buyers who underestimate the time-commitment involved but it's a must these days. If you want to be prepared in advance, start pulling the following documents and keep them all together in one file:
1. Last three years of tax returns
2. A few forms of photo ID
3. If you’re a current homeowner, your existing mortgage details and monthly utility bills (estimate of total monthly bills is fine but you may just want to save a recent copy of each)
4. Current credit card(s) invoice to show balance
5. Paperwork showing current amount owing on any other open loans (e.g. car or student loan)
6. Last few pay stubs. You may also need a letter from your employer stating that you are a salaried employee (if that’s the case), what your annual salary is and how long you’ve been working there.
Where do you apply? While you can simply go direct to the bank or credit union where you do your everyday banking, it’s usually best to hire a Mortgage Broker who will streamline the process for you and negotiate the best terms on your behalf from all of the lenders and products available on the market, not just what one bank offers. They make their money from the lender and so it shouldn’t cost you anything to hire a Broker (although note that many lenders demand a valuation on the property you've purchased before approving your mortgage and you will need to pay for that home appraisal).
If you’re going it alone, remember the tips above and, when it comes time to firm up your mortgage, remember that contract terms are just as important, if not more so, than securing the lowest interest rate. Don’t get caught up with price comparisons alone when comparing lenders. Two of the most important things to look for are:
a) low penalty fees to break your mortgage before the end of the term. You can't predict the future and you don't want to face an astronomical penalty fee to break your mortgage early. $25k, $30k, even $50k in penalty charges is not unheard of but many smaller lenders will offer fees of just a few thousand dollars versus what the big banks will hit you with.
b) the ability to pay down your mortgage faster with lump sum payments. Even if you don't anticipate having extra cash any time soon, an inheritance, raise or bonus at work or co-habitation (and with it, dual-income) could change your financial situation quickly. You want the ability to lay down large, one-time additional payments per annum to pay down your mortgage faster.
Pre-qualification is typically not a firm contract (pre-approval definitely isn't) and you are most likely free to apply with another lender for your actual mortgage with no penalty, should you change your mind or find a better deal in the interim. Read the terms and conditions in your pre-qualification letter carefully though before switching. Just make sure that you don’t burn your bridges with the original lender in case the new application doesn’t get approved.
Join us again next week for Part II in our Mortgage Approval series when we’ll take you through what not to do between the date of pre-qualification and the date you firm up your mortgage to ensure you’re not denied. READ PART II ON MORTGAGE APPROVAL
James Harrison is the Founder and President of mortgages.ca and a Mortgage Broker with award-winning results. He is one of the top Mortgage Brokers in the country and has been listed as a CMP Top 75 Mortgage Broker every year in the business. James is also top 25 in Canada with Dominion Lending Centres.
Lead image by Castleski from Shutterstock.