How home loan pre-approval works

So, you’ve got your deposit saved and you’re beginning to make moves on the housing market? Whether you’ve recently begun your property search or are about to swoop in with an offer, pre-approval can be a helpful step in the process.

Not only can pre-approval offer some guidance on what sort of property you may be able to afford, it can also prove to vendors that you’re a serious buyer.

But what is it and how does it work? Read on for our guide on seeking pre-approval.

What is pre-approval?

Pre-approval is an indication of how much you might be able to borrow to purchase a property. Otherwise known as conditional approval, indicative approval, or approval in principle, it is an assessment of your potential borrowing power, subject to other conditions.

Although pre-approval does not guarantee you will be approved for a home loan, it can give you a good idea of what you may be able to afford. Pre-approval can help you to:

• Find out how much money you might be eligible to borrow.
• Learn what sort of property you may be able to afford.
• Appear a more serious buyer to vendors.

Types of pre-approval

There are two types of pre-approval your lender may assess you for.

• System-generated: This pre-approval type involves a quick appraisal, usually conducted online, of your financial position. The result can often be notified to you within a matter of hours, sometimes even less. Usually, it does not involve a credit check and, due to its quick nature, can be less accurate.
• Full assessment: This pre-approval process is more detailed and involves a more thorough assessment of your financial position. It involves the lender’s credit department doing a full assessment of your finances as well as a credit check.

While each method involves a similar amount of paperwork for you, the method used can impact the accuracy of your appraisal.

For example, while a system-generated pre-approval can often be completed within a day, your application will usually not be assessed by the lender’s credit department. This means that when you apply for your official home loan there’s a greater risk of your finance application being rejected.

A full assessment, however, is a more accurate reflection of your financial position, but also has drawbacks. Being more thorough, it can take much longer than a system-generated approval. Its credit check could also have an impact on your credit score, through leaving an enquiry on your credit history.

Who can get pre-approval?

Anyone can apply for pre-approval, but not everyone may be approved. Pre-approval is dependent on individual lender criteria. Usually, lenders will look at:

• Savings. How much money do you have in genuine savings?
• Income. Do you have a consistent income? Will you be able to meet repayment obligations?
• Employment type. Some lenders may be less willing to lend to self-employed people,casual workers, and pensioners.
• Assets. Do you own any other property?
• Debt. Do you owe money on other loans?
• Living costs. What are your incomings versus your outgoings?

Depending on the type of pre-approval your lender assesses you for, the lender may also consider your credit score.

When to get pre-approved?

Pre-approval can be sought at any stage in the home buyer's journey.

While some may seek pre-approval early in the process, to get a benchmark figure of what they may be able to afford, others will apply right before they plan to put an offer on a house. House-hunters attending an auction may also wish to seek pre-approval, to help them calculate their maximum bid.

Although helpful, pre-approval is not a necessity, and some may not seek it at all.

Before applying for pre-approval, it’s important to keep in mind:

• Validation period. Pre-approval is usually only valid for a certain period before it expires. In most cases, this is 90 days, but could be as long as 180 days.
• Change in circumstances. If you have a change in financial circumstances within the pre-approval period, it may no longer be valid. This could include losing your job, seeing a reduction in income or taking on new debt.

What do I need to apply?

To apply for pre-approval, you will need a range of documents to prove your financial position. This could include:

• ID documents (e.g. driver’s licence, passport, birth certificate)
• Proof of employment and income
• Most recent ATO income tax assessment (this can help prove income if you’re self-employed)
• Bank statements
• Proof of savings
• Completed application form

Minimum requirements may change between banks.

What are the steps involved?

The pre-approval process usually includes the following steps:

1. Gather relevant documents and complete the application. This could include gathering points of ID, bank statements, proof of savings, etc.
2. Wait for the application to be reviewed by your lender. Depending on your application type and the lender, this could take anywhere from a matter of minutes to several days.
3. Application outcome. Your lender will let you know whether your application has been accepted, and if so, how much you are pre-approved for.

It’s important to note that pre-approval is not a guarantee of future finance. It may also carry certain conditions, and you may not be pre-approved for all types of property or locations.

Before placing an offer on a property, be sure to check any terms or conditions with your lender.

Will pre-approval affect my credit score?

Having a good credit score is important when applying for a home loan, so you may be concerned that pre-approval could hurt your score and complicate your application.

Depending on the lender’s pre-approval process as well as the number of pre-approval applications you make, it may or may not impact your credit score.

A system-generated pre-approval is not as detailed as a full assessment, and usually does not involve a credit check. This assessment type will have no impact on your credit score.

A full assessment, however, usually includes a credit check, and can affect your credit score. We explain how below.

Pre-approval and its impact on your credit score

Any credit enquiry – such as a loan application – involves the lender making a so-called “hard” enquiry, which appears on your credit report and can have an impact on your credit score.

However, while one hard credit enquiry won’t make too much of an impact, multiple enquiries within a short period can raise red flags. This is because it could appear that you are in financial trouble and are making multiple loan applications.

Before applying for pre-approval with a lender, ask if the application includes a credit check. If so, consider how many enquiries you have made lately and then decide whether you want to go ahead.

How to improve your chances of being pre-approved

• Build up your savings. Show the lender that you have a strong savings history and the means to cover a home deposit.
• Stable employment. Demonstrate a steady income stream to help prove your ability to cover mortgage repayments.
• Pay off other debt. Outstanding debt can reduce your borrowing power or even lead to your application being rejected if you already have a lot of debt. The less you have, the better.
• Improve your credit score. Among other things, ensure any bills are paid on time (especially on the run up to when you will be applying).

What happens if my application is declined?

Although it’s not the outcome you hope for, from time-to-time pre-approval applications are rejected.

If your application has been rejected, it’s important to understand why by asking the lender for an explanation. This can help give you an indication of whether it would be worthwhile applying again with another lender, or whether it would be best to put things on hold.

While in some cases you might have a good chance of being pre-approved with an alternative lender, in others it may be best to take a break. This time can be used to work on strengthening your application.

For example, in some cases self-employed applicants may struggle to gain approval with the big banks but could have better luck with a specialist lender.

If you haven’t already, now may be the time to consult with a broker who could advise you on next steps.

Pros and cons