Locked In our Look Out? What it Really Means to Get Pre-approved

Getting a pre-approval is always the best first step and one that I highly recommend. Your broker will work with you to ensure that you understand the numbers, and it’s an important first step before heading out with your realtor on a search. But pre-approvals are far from set in stone.

What do I mean by that?

The very definition of “pre-approve” is to approve something in advance, like “in advance of having all of the information at your disposal”. What it means is that you can be assured that you qualify for a certain amount of dollars based on several different variables (some of which are best guess estimates).
A question I get asked a lot is – “if I have a pre-approval, I’m good to go right?” Right. But also, not quite.

Confused yet?

Ya figure you put that little box under your pillow at night, the Guarantee Fairy might come by and leave a quarter, am I right? (PS. If you can name the movie the above quote came from then you might be as old as me).

The short answer is that there really are no guarantees in life (save for death and taxes). And while a pre-approval assesses your details as a borrower, it does not assess the property. You may be a great borrower, but if the home you want to buy has any nuances (i.e. in an age-restricted building, a former grow-op, leasehold land, or rural or agricultural property) then the lender you have the pre-approval with may not even deal in that kind of property, rendering your pre-approval invalid.

Even for a standard property, value has yet to be established by way of an appraisal, so if you’re purchasing a $500,000 house that comes in at a value of $475,000 then it doesn’t matter what the pre-approval letter says, the maximum the lender is going to finance on that house is $475,000 (meaning the extra $25,000 is cash you’ll need to come up with).

Here is a list of a few things that can derail your pre-approval:

DOCUMENTS NOT REVIEWED UP FRONT – If your guaranteed hours are actually 37.5 instead of 40 hours a week it may not seem like a big deal at the time of the application, but that few hour discrepancy could be the difference between an approval and a decline when your deal goes live. Sure, your T4 says $85,000 but it is your pay stub that lenders are most concerned with. So if your salary is actually $75,000 and last year’s T4 included a one-time company bonus or benefit that you do not anticipate getting again, then the lender generally will not use that income in the application. And while it doesn’t seem like a lot of money, $10,000 in income is roughly $55,000 in mortgage dollars.

HIGHER THAN AVERAGE PROPERTY EXPENSES – Pre-approvals use estimates for property expenses such as property taxes, strata fees, and heat, so if these end up being significantly higher than first anticipated it could reduce the approved mortgage amount.

OVER-EMPHASIS ON BASEMENT SUITE INCOME – In this market, a basement suite can most definitely be the mortgage helper you need to get into your dream property, and it can influence the amount of mortgage you qualify for, but my advice is don’t count on one as a make or break given that market rents can vary significantly. If you based your pre-approval on finding a home with a legal 2 bedroom suite and $1700/month in rent, and the property you fall in love with has a 1 bedroom unauthorized suite, that’s not an apples to apples comparison and the lower rent will change the numbers you were working with.

PRE-QUALIFIED vs. PRE-APPROVED – Pre-approvals are applications submitted to a lender where a formal letter is issued including a rate hold. Keep in mind however that many of these lenders use auto-scoring systems for pre-approvals, so they haven’t necessarily had a human being look at your deal to confirm the details. Pre-qualified may simply mean that your bank or broker has reviewed your documentation and run the numbers to give you a suitable range to search in. In the latter case, it may not have been submitted to a lender for review at all.

EXPIRED PRE-APPROVALS – Generally, most pre-approval letters are only valid for anywhere between 90-120 days (and most lenders want a new credit bureau to be pulled after 30 days) meaning that if your circumstances have changed then your pre-approval will change as well. Read: DO NOT go out and get that large truck loan, new credit card, or line of credit without expecting it to impact to your pre-approval. In fact, if you’ve had any kind of material change to your circumstances (i.e. job change, change in marital status) since you first did the pre-approval, regardless of how much time has passed you should err on the side of caution and have your broker redo it.

HIGH RATIO PRE-APPROVAL – You can still seek a pre-approval with less than 20% down, however once the deal goes live there is another layer of approval that needs to be completed. One of the high ratio insurers (Genworth, CMHC, Canada Guaranty) needs to review and support the application, and while its not common for there to be a divide, there certainly have been situations in the past where the lender has said YES and the insurer has said NO.

My best advice to avoid disappointment is to work within your reasonable payment range. Generally, when a broker asks, ‘what payment can you afford?’ most people respond with, ‘whatever you can qualify me for’ which can make for a dangerous formula. Remember that mortgage approvals are based on gross (see – BEFORE tax) income and what you qualify for verses what you want to pay are not always one and the same. With pre-approvals it often feels like a race to the top in terms of what the bank or broker can qualify the borrower for throwing in everything but the kitchen sink, and it’s definitely a mistake I’ve made in the past with clients that I won’t be repeating anytime soon.

Don’t discount how important a budgeting discussion with yourself is before you move forward with an application as this will help you land in the most realistic and reasonable price range. If you know you’re going to have an additional $500/month in property expenses that you didn’t have when you were renting (i.e. property tax, strata, utilities) then you may not want to set your mortgage payment the same as your previous rent if it was already stretching your limits.

We live in a very (VERY) expensive Province and it can be disheartening and frustrating for buyers trying to make their dollars work for them in this market, so it’s not surprising that a lot of pre-approvals tend to be right up to the limit of the legislated maximums. I’ve included a scenario to show how tight the pre-approval game can really be:

2 clients with combined income of $95,000 10% down payment saved ($50,000) No debt other than 1 car loan at $300/month and a Visa with a $1000 balance ($30/month) Pre-approved for a Purchase Price of $500,000 (assuming property taxes no greater than $2500/year and strata fees not to exceed $300/month and heat of $75/month) The ratios (GDS/TDS) on this are 38.8/43% (maximum allowable for a high ratio mortgage is 39/44% with credit above 680) so as you can see this is right on the wire. Now, for example, let’s say this couple makes an offer on a property right at $500,000, however it’s a townhouse complex with a pool so the strata fees are higher at $475/month.

GDS is now 39.9% which is over the maximum allowable and will be declined by the insurer. Sounds crazy right? That $175 in strata fees could blow up a deal, but with guidelines the way they are this is very much a reality.

OR…

Let’s say they find a great place at $500,000 with taxes of $2000/year and strata of $200/month, lower than expected. Not a problem, right? The only thing is that the couple got excited about their pending move and purchased some new furniture on a store card ($5000) and they ran up their Visa to it’s limit of $5000 on a recent trip to Whistler.

TDS is now 45.2% which is over the maximum and will be declined by the insurer

Short answer is that when it comes to less than 20% down the rules are hard and fast and ratios that are over the stated limits by even a decimal point can blow up a deal.

It’s a lot to digest, I know. Getting a pre-approval is still a highly recommended step in the process, and if you set a budget based on what you can reasonably afford then you will likely not have an issue. And yes, there’s slightly more flexibility with 20% down payment along with various specialty programs designed for unique situations, but those are the exceptions and not the rule. It’s still a best practice to ensure that you’re working within the debt servicing guidelines, and taking a conservative approach will prevent some serious disappointment when it comes down to crunch time.

Questions? Let’s talk.