Many first home buyers opt to get Approval in Principle (also called pre-approval or conditional approval) when they start house hunting. As well as giving you an indication of your borrowing power, it means that you can make an offer on a property with extra confidence.
Here, we explore the what, why and how of getting a pre-approval on a home loan.
What is Approval in Principle?
Approval in Principle (AIP) is generally an indication from a lender that they may be willing to lend you a certain amount of money subject to specified conditions.
Generally, getting an AIP shouldn’t cost you anything.
It’s important to note that AIP is not a guarantee that you will be approved for a home loan. AIP is subject to certain conditions, one of which is the lender’s valuation of the property.
Why does your lender need to do a valuation? Good question.
If a borrower defaults on their loan, the lender has the right to recover the outstanding loan amount by selling the property. In other words, the property is security for the home loan. Getting a valuation provides assurance to the lender that the property is a suitable security. The valuation is also used to calculate the loan to value ratio as part of the assessment for the final loan approval.
Why get Approval in Principle?
As a first home buyer, you could get the following benefits from getting a pre-approval on a home loan. For a purchase of a property, an AIP:
- can give you an idea of your borrowing power, so you know your limits when house hunting
- can help you plan your budget
- could give you more confidence in making an offer
How do you apply for Approval in Principle?
Seeking pre-approval on a home loan can be quite simple. Before you get started, you may want to think about your budget and borrowing power so you know roughly how much you can afford to borrow. It can also be useful to do some research into the best home loans for your situation.
Every lender will have different rules and processes for applying for AIP. Generally, you may need to provide evidence of:
- your income, expenses, and employment
- your savings record
- the amount of deposit you have saved
- any debts that you currently owe (e.g. credit card, personal loan)
- your identity.
You may also need to tell the lender the price range of the properties you’re looking at.
When should you apply for Approval in Principle?
You may want to apply for Approval in Principle before you start looking for a home so that you have an indication of how much a lender is willing to lend you based on the information you’ve provided.
How long does Approval in Principle last?
Generally, presuming that your circumstances don’t change, your pre-approval will last for around three months. This timeframe may differ from lender to lender.
During the time that your AIP letter is valid, you can look for houses with more confidence in knowing the lender is likely to lend you a certain amount of money – subject to conditions including the property being an acceptable security to the lender.
If any of your circumstances change – such as your income, expenses, or type of employment – let the lender know as this may affect how much they could be willing to lend you.
If your pre-approval expires before you have signed a contract on a home, you will have to re-apply for another pre-approval. You should speak to your lender about their policy.
Pre-approval, conditional approval, unconditional approval. What's the difference?
As mentioned above, pre-approval is a lender’s indication they may be willing to lend you a certain amount of money. It can also be called conditional approval.
Unconditional approval otherwise known as full approval indicates that a lender is willing to move ahead with a home loan of a specific amount for a specific property. Of course, just because it is unconditional it doesn’t mean you have to accept the loan and borrow the money.
What about placing an offer on a property 'subject to finance'?
Even if you have pre-approval for a home loan, you may want to make your offer ‘subject to finance’. That way, if your lender declines your home loan application, then you may have the right to withdraw your offer.
Whether you choose to make an offer ‘subject to finance’ or not is up to you. You should seek advice from your solicitor or conveyancer before making an offer so that you are fully aware of your rights and responsibilities.
If you are buying at auction, subject to finance conditions are generally not allowed. You should seek guidance from your conveyancer or solicitor before you start bidding.
When could an Approval in Principle be declined?
AIP does not guarantee you will get a home loan. There are various things that may cause your home loan application to be declined – even if you have a valid pre-approval letter in your hands. For example:
- the lender may get the property valued and determine that the property value does meet the lender's LVR requirements
- the property may not be acceptable type to the lender (e.g. the apartment is smaller size than what's accepted by the lender)
- there may be a change in your circumstances that impacts your financial position.
Always ask your lender about their criteria before you put an offer on a property.
To sum up
- Approval in Principle (or pre-approval) can give you an indication of how much you could borrow from a particular lender.
- Getting pre-approval is generally free of charge.
- Pre-approval can help when house-hunting as it gives you a better indication on a price range to shop within.
- Having pre-approval doesn’t mean you will definitely get a home loan.
- Lenders attach certain conditions to pre-approval letters – generally, all conditions must be met to get your home loan.