What is a Pre-approval and why do I need one?

Why does every keep talking about pre-approvals? Simple. A pre-approval is leverage. 

In its simplest form, a pre-approval means you the buyers have had a mortgage professional and a lender review your file to ensure you qualify for the mortgage you are seeking. You are shopping for houses within your affordable price range. The lender has set some funds aside for you, reviewed your credit history, and secured an interest rate for you for the next 4 months while you shop. 

Great, now I get it but how is this leverage?

The current real estate market is extremely competitive. Having your financial house in order is a tool you can use to your advantage to help you win when negotiating. There are more buyers than there are sellers at the moment, creating a seller’s market. Seller’s not only want to sell quickly and for the most amount possible, but they also want to ensure the sale proceeds smoothly. 

How does a sale go smoothly? Again, simple. A qualified buyer with their financing in order will likely not cause delays, allow the house to close in a timely manner, and net the sellers the agreed-upon sale price. This lets the sellers move on to their next house with ease.

Say you’re competing with other buyers on a house. You’re pre-approved, the other buyers are not. Which offer do you think the sellers are likely to accept?

  • Offer 1:
    • Offered the same price the sellers are asking and clients are pre-approved 
  • Offer 2:
    • Offered more than what the sellers are asking but clients are NOT pre-approved

More often than not, offer 1 holds more weight compared to offer 2. Why? Yes, the extra cash is nice BUT there’s no guarantee that that offer will be successful when it comes to securing the mortgage. These clients have not done their homework and put their best financial foot forward.

Do yourselves a favour, before you go out looking at houses and falling in love with things you may not be able to afford, get your pre-approval. It’ll help you narrow down your search, compete efficiently and effectively when the right house does come up, and help you win if you find yourselves in a competitive situation. 

Want some more nitty-gritty details on pre-approvals?

Typically a pre-approval is based on a 5-year fixed-term or a 5-year variable term. There are other terms available, but as these are the most commonly secured terms, these are the most commonly held pre-approval rates from the majority of lenders. 

A pre-approval, in most cases, is valid for 120 days (so roughly 4 months). It secures your interest rate over that period of time, meaning if rates rise, you are protected. What if rates decrease during those 4 months? A trusted mortgage professional will search out the best product and rate for you once you have an accepted offer to purchase ensuring you get the best rate and product that fits your needs. 

What do we assess during your pre-approval? The 5 C’s of credit:

  • Credit – the strength of your score and credit history. To qualify for the best options on the market, you will need a credit score of at least 620, but ideally over 680, and no blips in the last two years.
  • Capacity – determines your ability to repay the loan you are requesting and manage any unforeseen circumstances. This is why sticking to your budget is important.  
  • Capital – your skin in the game. How much of your own funds are going into the purchase, what does your fall back savings position look like?
  • Collateral – are you buying a good house? Was it previously a grow op? Any major maintenance issues that may cause issues down the road or bring on a large contractor bill? What about the location of the house, is it desirable or one of a kind?
  • Character – what kind of borrower are you? Do you have a history of credit-seeking behaviour? Have you managed your finances well? Do you have job stability? 

Along with the 5 C’s , we also review your debt servicing ratios. Debt servicing ratios are based on your income, new mortgage payment, property taxes, heat & utilities, condo fees, and any other monthly financial obligations you have ( i.e. car laon, credit cards, student loans, etc.). 

For traditional mortgages,  your overall expenses cannot exceed 42% to 44% of your overall income. 

Don’t rely on online calculators to calculate your own affordability. There are strict guidelines on how we must assess different financial obligations. It’s best you leave this to a skilled mortgage professional. 

Lastly, rules change often when it comes to qualifying for a mortgage. Just because you were pre-approved last year does not mean you will qualify for the same mortgage the following year. Please, spend the time getting pre-approved, you’ll thank yourself and your realtor will too. 

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