What Does Getting a Mortgage Pre-Approval Actually Do?

So you’ve decided to purchase a home and it’s time to start thinking about the finances. Chances are you’ve probably heard of getting a mortgage “pre-approval” before, but what does that actually mean?  As you can probably imagine, getting pre-approved for a mortgage means a lender has checked your information and “approved” your application to borrow up to a certain amount, but do you need to get one to shop for a home, and more importantly is that approval a guarantee?

In this article we’ll answer all of your questions regarding mortgage pre-approvals and if it’s the right move for you to get one.

Income, credit, assets, liabilities, down payment, and other properties owned are the key factors involved in underwriting your mortgage and will all have an impact on your mortgage pre-approval. These factors will all be examined in your application for a mortgage pre-approval. Let’s talk about what each of these factors are and why they’re important to the lender:

Income – Regardless of how your income is earned, it will need to be confirmed with documentation so the bank can gauge how much mortgage you can afford on a monthly basis, and in turn, how much you will be pre-approved for.

Credit – The 5 C’s of Credit are considered in evaluating the credit part of your pre-approval: character, capacity, capital, collateral, and conditions. Your score needs to be within a certain range so the bank can evaluate your ability to repay the mortgage loan, and takes into account among other things, your past credit repayment history.

Assets – Liquid and non-liquid assets (such as vehicles or household goods) are all considered on your application. This reflects your net worth, and savings patterns. Your down payment may be included in this category.

Liabilities – Any credit accounts or debts in your name will be considered. Your liabilities can also include payment obligations such as child support, private loans, or income taxes owing. 

Properties owned – If you already own property and are getting pre-approved for another home, this will have an impact on your application. This includes any property you may have co-signed for with a friend, parent, sibling or other family member. The lender will consider if you are selling that property and increasing your net worth, or if you need to continue making mortgage and tax payments on the existing property, whether or not it’s owner occupied or a rental. 

The lender will need to see proof of your down payment as well as the amount which can range from a minimum of 5% – 20% of the purchase price. Typically, acceptable down payment sources are saved funds (held in savings or investment accounts), gifts from an immediate family member, proceeds from the sale of another property you own, and borrowed funds from a Line of Credit. Other acceptable sources can include inheritances, court awarded settlements, and trust funds. 

Documentation confirming the funds are available for the down payment are always required by the mortgage lender in a pre-approval. For example, if the down payment source is from the sale of an owned property, you would be required to provide proof of that property being sold (via Signed Sale Agreement from a realtor), plus a mortgage statement confirming how much of the sale proceeds will be paid back to the bank.

Once the source of your down payment has been discussed and confirmed with the lender pre-approving your mortgage, and they’ve verified your other information, you are ready to obtain a pre-approval. 

Your mortgage pre-approval will include the maximum purchase price that you qualify to purchase a home for from that lender. It will consider all of the factors mentioned above in the evaluation, including your down payment. Your full name will be included on the pre-approval and it will usually be signed-off on by a mortgage advisor or broker from the lender.

However, a mortgage pre-approval is not a legally binding contract, and you can’t always take it to the bank (literally). While in the vast majority of cases a mortgage pre-approval all but confirms your ability to borrow the stated amount from the lender, if you or the lender has made a mistake or misrepresented some information in your application (like say a massive debt that you hid) then the mortgage underwriter may still deny the loan. Additionally, a pre-approval doesn’t guarantee you will get a specific mortgage rate when it comes time to finalize the financing.

The purpose of the mortgage pre-approval is to confirm your maximum purchase price, this is basically your license to shop for a home! It provides a guide to what you can and cannot afford based on the information you provided to the lender. 

The pre-approval aims to provide predictability and smoothness in your home purchasing transaction. If you don’t have a pre-approval, there is no way to gauge how much you can afford, and if you purchase a home you cannot afford, it may be very costly or difficult to obtain financing. If you are unable to obtain financing after you have purchased a home, this can lead to other issues, so without a pre-approval, it’s typically recommended to include a financing condition in your home purchase conditions. 

While a pre-approval isn’t a guarantee you will be able to obtain financing, it usually provides a clear and predictable amount with which you can make your home buying plan that you can make updates to at any time, should your income, credit, or down payment situation change. If you are in the market for a new property, talk to your mortgage advisor about getting your pre-approval to minimize some of the stress and guessing involved in purchasing a home.

To get an estimate of how much mortgage you can afford, check out our mortgage qualifier tool.

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