The Intricacies of Mortgage Pre-Approvals

Special to CMT, By Rick Robertson
Mortgage Mentor Inc.


 

Pre-approvalWhile doing some research recently, I called a number of Realtors and mortgage borrowers to get their definitions of a “pre-approval.”

After compiling their answers, here were two common responses:

  • A confirmation or certificate that gives a borrower the assurance to write a purchase offer without a “Subject to Finance” clause.
  • The process of calculating debt service ratios (DSRs) and reviewing support documents to determine if the borrower meets a particular lender’s guidelines for funding.

In studying Canada’s broker-friendly lenders, we’ve found many variations in pre-approvals, but just one common reality:  Virtually no lender actually offers a pre-approval that matches the marketplace’s definition.

That actually wasn’t a surprise. What did surprise us, however, were the comments of two lender executives we interviewed. When asked to define the difference between a pre-approval and a rate hold, they confidently stated that both “are the same thing.”

In most mortgage professionals’ opinions, pre-approvals and rate holds have different meanings. Pre-approvals are generally seen as being more thorough and underwritten while rate holds are simply a rate guarantee.

Confusing the issue further is that some lenders offer what they call a “pre-approval,” but it’s actually just a “rate hold.”

Our research of broker channel lenders revealed several policies that must be considered when choosing the optimal pre-approval or rate hold. Here’s what we found:

  • Detailed borrower information and/or documents are typically required to get a full underwritten pre-approval.
  • For simple rate holds, few lenders actually review any documents.
  • Some lenders (at least four by our count) will not grant a rate hold if there is no subject property information.
  • Numerous lenders add rate surcharges for rate holds (but some don’t).
  • Most lenders do not offer rate holds on refinances.
  • Only three lenders allow borrowers to change to a different term at the rate available on the day of the “hold”.
  • If rates fall, the majority of lenders will drop a client’s rate at the broker’s request.  Four lenders will automatically give the client a rate drop.
  • Seven of the lenders we spoke with assess brokers’ funding ratios based on follow-through of rate holds/pre-approvals. (Funding ratios are, of course, used to determine broker compensation, status and/or eligibility at various lenders.)

With all the variations and permutations, it’s a wonder that mortgage brokers can keep up with pre-approval guidelines. For the typical consumer, this is one area where discussion with an experienced broker is time well spent.


‡ One of a handful of exceptions that offer close to a full-fledged pre-approval (with document checking) is First National. But it does so on an exception basis and cancellations (of converted pre-approvals) affect the broker’s funding ratios. Although this lender calls it a “pre-approval”, the process is that of a full-on approval except for property information. To be safe, however, a purchase offer should still be conditional on the lender’s acceptance of the property. (The property must also meet appraisal value, default insurer guidelines, be marketable, be eligible for fire insurance and title insurance and be free of hazards, etc. Pre-approvals almost always leave some questions unanswered.)
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Rick Robertson is President of Mortgage Mentor Inc., a firm specializing in the development of lender selection and finance option calculation software.

  1. Yes you must always have a financing condition in your offer when buying a house with borrowed money. The lender may have approved YOU as being good for the money but they haven’t looked at the house yet, the one you’re putting up as security. Maybe the house is worth less in the eyes of the bank than you’re willing to pay for it. Maybe it doesn’t meet the lender’s guidelines (example: some won’t touch past grow-ops). So yes, a finance condition should be standard.

  2. This is one of the things my broker and agent both made sure I was aware of. Even though I was pre-approved through First National, we always put a ‘conditional on finance’ in our offer. I would rather lose the house, than the deposit.

  3. Because this a major investment of a buyer’s money they need to safeguard themselves as much as possible when an offer to purchase a home is submitted. Regardless of whether they have a rate hold or pre-approval if it is for 60-90 days a lender will want a credit bureau check that is less than 30 days old. Perhaps the buyer went out and put some major purchases on their credit card and this has pushed them over the GDS and TDS limits.The lender will also be protecting their interests by doing their due diligence..
    If you do not put a financing clause in, perhaps to have a `clean`offer, and you cannot get financing you can be sued by the seller and by the buyer`s of your home if closing does not occur.
    Even if it turns out that in the end you did not need the clause, it is better to have it in than be financially sorry in the end.

  4. Hi Rick, thanks for the great article and story. You are very true that most mortgage lenders/brokers do not distinguish what a pre approval is vs a rate hold. Educating your clients about what it means to be pre approved from the very start is important. The lenders that I work with on a regular basis actually fully underwrite their pre approvals (obviously subject to the property details when firm) and they provide a client with a solid basis for understanding what they qualify for. As a mortgage professional I would never advise a client to put a CMHC offer in without a condition of financing as it is not a risk or liability I can take on or a wise decision to do. That is a very difficult position to put yourself in especially with the way the appraisers/lenders/mortgage insurers are so unpredictable these days. In Toronto your offer gets laughed at if you put a condition of financing in and I discuss the options and potential outcomes with clients and discuss the alternatives (i.e. if they are declined by lender/CMHC the possibility of alternative lenders and/or coming up with more downpayment) and allow them to weigh the options and make their own decision. I’ve gotten involved 1/2 way through a deal after clients have been told by their broker or banker that “everything is fine” and that there is no need for a condition of financing only to have it blow up as the broker/banker didn’t ask the right questions. One of my requirements that I demand of clients that they provide me with their income confirmation up front, especially if they are self employed- too often clients write on their application that they make $100K only get tax returns sent that show a net of $25K and the deal blows up. It is important as mortgage brokers that we ask the right questions up front so that the pre approval we give our clients is as firm as possible.
    ***One thing I would like to point out that is inaccurate in this article that you should have fact checked in a little more detail is that First National offers fully underwrote pre-approvals for EVERY file- not on an exception basis and they have been doing so for as long as I remember. The other inaccuracy is regarding their funding ratios. The deals that go towards the funding ratios are REAL DEALS CLOSED and REAL DEALS CANCELLED. Not DECLINES and not PRE APPROVALS that have been cancelled.

  5. HI Jason, I appreciate the feedback. I actually do spend a LOT of time fact checking and the First National information was checked through 4 levels of management before the article was finalized. First National does not underwrite EVERY file, and we should not expect them to if they are busy with live deals. (I personally just had two such yesterday – that came back with a “Rate Hold Only” note) Regarding the funding ratios; if the “Pre-Approval” becomes an approval, is then accepted by the borrower and subsequently cancelled, only then will it affect funding ratios.

  6. The core of this story is that we the few (Mortgage Brokers and Lenders) are out of sync with the many (General Public and Realtors) in our terminology regarding rate holds.
    If we want to keep improving our image as THE Trusted Advisors in the residential mortgage market, we need to become accurate and consistent in how we’re presenting these “Approvals” & “Holds”.
    I see merit in sending this article, or similar, to every Realtor we know.

  7. I believe as a broker the best strategy is to underwrite your own deal when it comes to a pre-approval and simply use the lenders to hold your rates. A broker should be well informed on the guidelines and requirements of each lender and therefore this should not pose a problem. Far too many brokers rely on lenders or underwriters for a certain lender to do their job for them, its a big problem.

  8. Our best practices are to underwrite our pre- approvals. You may have been given a note rate hold only as a polite warning that we see some challenges with the deal but with rates moving we wanted to ensure you the rate. We can not guarantee insurers will always be onside with our mitigation and rationale but we do our best to underwrite all pre – approvals, asking all questions up front where there a holes in the interest of giving a realistic pre- approval. So I can confirm that First National DOES underwrite all pre-approvals for our broker partners so we are doing our best to avoid misleading your clients in terms of qualification.

  9. Hi Lender, You have exactly demonstrated the challenge that this article is addressing. There is misuse of the term “Underwriting” as much as there is the term “Pre-Approval”. The article was intended to communicate is that with a Pre-Approval (as understood by Realtors and consumers) means that the only thing a borrower needed to complete the full approval process would be a purchase agreement and possibly an appraisal. “Underwriting” in this context means that the lender has received, reviewed, and accepted ALL the documents confirming: employment, income, taxes paid, equity or down payment, credit, etc. “Underwritten” in the best sense, and in the context of this article, means more that a careful review of the application, credit bureau, and checking the ratios.
    Our industry needs some better STANDARDS for terminology like “Pre-Approval”, and “Underwritten.”

  10. I think one of the issues that needs to be addressed with the issue of funding ratios is the that very few lenders actually provide complete underwriting guidelines to work with
    How they expect us to underwrite our files without quality comprehensive guidelines and give them the quality applications they want is a mystery.
    I have had situations where the BDM of a lender insisted that they fully underwrite all files while the underwriter claimed they never do as a pre-approval.
    Go figure.

  11. Hi folks,
    Further to First National and its pre-approval policies:
    First National does not fully underwrite pre-approvals (meaning, review documents) unless the broker specifically requests it. If volume is high, First National may initially issue a rate hold only, as opposed to a fully underwritten pre-approval.
    If the pre-approval is cancelled but never converted to a live deal, it does not count against the broker. If a pre-approval is converted to a live deal, and that deal is cancelled, it does count against the broker. As with most lenders, brokers can lose their pre-approval privileges if they submit a large number of pre-approvals but close very few.
    All this said, First National has one of the best pre-approval underwriting policies in the broker channel. We’re lucky to have them as an option.
    Cheers…
    Rob

  12. B2B Bank is similarly helpful as First National. Just this morning B2B confirmed that they will do Pre-Approvals for “Status” brokerages. They do require a full client document package to be submitted which will be “Underwritten”. Note that: Default insurance cannot be obtained unless the property address is available, and “fresh” job letters will be required if the ones presented are more than 30 days old at time of funding.
    As per advice given by others earlier in this thread – the client should still have some form of ‘Subject To…’ for protection in the event that the last minute details are not acceptable to the lender and/or insurer.

  13. It’s my understanding that CMHC does not do any kind of pre-approval therefore no high ratio deal, regardless of the lender, is ever pre-approved by any definition…

  14. Which is why a very good alternative to a broker pre-approval is for client to obtain a ‘prequalification’ from a major bank. The bricks and mortar banks generally provide a full prequalification including documentation inspection, it’s not just a rate hold or an opninion by the bank rep, but a full blown proper qualification reviewed by the credit centre. The exception is of course CMHC/Genworth who do not provide prequalifications opinions.

  15. I don’t think all the major banks check documents on “pre-approvals.” Without a property appraisal a pre-approval is only good for the rate hold anyway. Any experienced broker/banker can look at documents and prequalify a borrower.

  16. My mortgage agent took a lot of time time explaining the mortgage pre-approval process to me. The best thing about a pre-approved mortgage is that it keeps you safe from the sudden fluctuations in the mortgage industry. I had taken my second home mortgage after getting pre approved from 5 Year Mortgage Rate at Toronto, and they offered me a 120 days rate guarantee period which is one of the highest a lender may offer.

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