It's finally happening... You've found a great site, you've done the numbers and the due diligence and everything stacks up. You've got a pre-approval for finance. The only thing left to do is make an offer.
Except the vendor wants an unconditional offer. No worries, you think, I've got a pre-approval, it's all good. I can do it.
Until you can't.
Okay, so maybe I'm painting a worst case scenario here, but the fact is there's a lot more to pre-approvals than most people realise. So let's take a deep dive into pre-approvals and how to make sure you don't end up in the situation I've described above.
Finance pre-approvals can be a helpful tool for property developers. They provide insight into the amount of credit or financing you may qualify for, helping you make informed financial decisions. A good mortgage broker who understands finance for developers is a crucial part of your team, and should be able to give you an idea of what amount of finance you qualify for, with or without a pre-approval.
However, there are some potential pitfalls associated with finance pre-approvals that you should be aware of.
Credit Checks
Applying for pre-approvals often involves a credit check, which can temporarily lower your credit score. If you apply for multiple pre-approvals within a short period, it can have a cumulative negative impact on your credit score. Be strategic about when and how you apply for pre-approvals to minimise this effect.
Keep in mind, too, that some lenders will see multiple pings on your credit history and get worried, even if there's nothing wrong. Lots of credit checks but no loans as a result is a big red flag for them. It makes them wonder why everybody else is rejecting your applications.
A Pre-approval Is NOT An Approval
This one happens a lot. Just because a lender has indicated they would be willing to lend you a certain amount, you should never assume they actually will. This is particularly true if the pre-approval is more than a few weeks old.
For example, just say the RBA raised interest rates in the meantime. Guess what - the lender will now have new criteria for judging your capacity for a loan.
Now, if you're playing in the commercial finance space that's probably not such a big deal, assuming you have enough fat in the deal to absorb the extra interest costs. But residential finance? An interest rate rise will definitely impact your serviceability. The lender may reassess your financial capacity, and only approve $100k less than they said in the pre-approval.
Leaving you high and dry if you bought a property for the original amount they allowed in the pre-approval.
Check the fine print - most pre-approvals last for three months, but it's better to be sure.
Incomplete Information
Pre-approvals are typically based on the information available at the time of application. If you provide incomplete or inaccurate information, the pre-approval may not accurately reflect your financial situation. This can lead to disappointment when you apply for the actual loan or credit and are approved for a different amount or interest rate.
It can also lead to a situation where the lender chooses not to lend to you at all, if they think you were trying to do something dodgy. In fact, it doesn't even need to be dodgy - lenders can still deny your application if they uncover issues during the underwriting process. So make sure your application is as complete as you can make it (with guidance from your broker so you don't over share unnecessary information!).
That also leads into...
Change Of Circumstances
Your financial situation can change between the time you receive a pre-approval and when you actually apply for the loan. Job loss, changes in income, or increased debt can impact your eligibility and the terms offered to you. The pre-approval may not accurately reflect your current financial picture.
Again, this is mostly relevant to residential finance, but commercial finance can be impacted as well. Take a market which turns and prices for your end product start to drop. If they drop quickly enough, you may find a lender having issues with your feasibility numbers and lending you less as a result.
Hidden Fees and Costs
This comes up at the initial stage of looking for finance. It's really important to compare apples with apples. Lenders are forever coming up with clever ways to incorporate fees into the process, particularly in the commercial space, and those fees can add up to a substantial burden.
Pre-approvals may not include all associated fees and costs, such as closing costs on a mortgage or origination fees on a loan. It's crucial to understand the full cost of the financing before proceeding.
It's even more crucial to make sure that when you're comparing multiple offerings, all the fees are taken into consideration. Otherwise one lender's pre-approval might look really positive, only to become really expensive when you discover fees like success fees, line fees and more.
Extension Costs
This is also something to keep in mind. While we all like to think our projects will run to our projected timeframe, and even allow a little bit more time to make sure things are complete before the finance expires, there are times when that just doesn't happen.
So again, if you're looking at multiple lenders, look at what's going to be involved if you need to extend the loan. Will the lender require you to make a whole new application, with all the associated fees needing to be paid a second time? Or do they have a mechanism in place to negotiate an extension?
As a side note - if you find yourself in that situation, start negotiations early!
The bottom line is that a pre-approval is NOT a guarantee of finance, and even if the finance comes through, it may not be what you were expecting.
To navigate the potential pitfalls of finance pre-approvals effectively, it's essential to review the terms carefully, maintain accurate financial records, and regularly monitor your credit report. Additionally, seek guidance from an experienced broker to help you make the best choices in regards to finance.
Except the vendor wants an unconditional offer. No worries, you think, I've got a pre-approval, it's all good. I can do it.
Until you can't.
Okay, so maybe I'm painting a worst case scenario here, but the fact is there's a lot more to pre-approvals than most people realise. So let's take a deep dive into pre-approvals and how to make sure you don't end up in the situation I've described above.
Finance pre-approvals can be a helpful tool for property developers. They provide insight into the amount of credit or financing you may qualify for, helping you make informed financial decisions. A good mortgage broker who understands finance for developers is a crucial part of your team, and should be able to give you an idea of what amount of finance you qualify for, with or without a pre-approval.
However, there are some potential pitfalls associated with finance pre-approvals that you should be aware of.
Credit Checks
Applying for pre-approvals often involves a credit check, which can temporarily lower your credit score. If you apply for multiple pre-approvals within a short period, it can have a cumulative negative impact on your credit score. Be strategic about when and how you apply for pre-approvals to minimise this effect.
Keep in mind, too, that some lenders will see multiple pings on your credit history and get worried, even if there's nothing wrong. Lots of credit checks but no loans as a result is a big red flag for them. It makes them wonder why everybody else is rejecting your applications.
A Pre-approval Is NOT An Approval
This one happens a lot. Just because a lender has indicated they would be willing to lend you a certain amount, you should never assume they actually will. This is particularly true if the pre-approval is more than a few weeks old.
For example, just say the RBA raised interest rates in the meantime. Guess what - the lender will now have new criteria for judging your capacity for a loan.
Now, if you're playing in the commercial finance space that's probably not such a big deal, assuming you have enough fat in the deal to absorb the extra interest costs. But residential finance? An interest rate rise will definitely impact your serviceability. The lender may reassess your financial capacity, and only approve $100k less than they said in the pre-approval.
Leaving you high and dry if you bought a property for the original amount they allowed in the pre-approval.
Check the fine print - most pre-approvals last for three months, but it's better to be sure.
Incomplete Information
Pre-approvals are typically based on the information available at the time of application. If you provide incomplete or inaccurate information, the pre-approval may not accurately reflect your financial situation. This can lead to disappointment when you apply for the actual loan or credit and are approved for a different amount or interest rate.
It can also lead to a situation where the lender chooses not to lend to you at all, if they think you were trying to do something dodgy. In fact, it doesn't even need to be dodgy - lenders can still deny your application if they uncover issues during the underwriting process. So make sure your application is as complete as you can make it (with guidance from your broker so you don't over share unnecessary information!).
That also leads into...
Change Of Circumstances
Your financial situation can change between the time you receive a pre-approval and when you actually apply for the loan. Job loss, changes in income, or increased debt can impact your eligibility and the terms offered to you. The pre-approval may not accurately reflect your current financial picture.
Again, this is mostly relevant to residential finance, but commercial finance can be impacted as well. Take a market which turns and prices for your end product start to drop. If they drop quickly enough, you may find a lender having issues with your feasibility numbers and lending you less as a result.
Hidden Fees and CostsThis comes up at the initial stage of looking for finance. It's really important to compare apples with apples. Lenders are forever coming up with clever ways to incorporate fees into the process, particularly in the commercial space, and those fees can add up to a substantial burden.
Pre-approvals may not include all associated fees and costs, such as closing costs on a mortgage or origination fees on a loan. It's crucial to understand the full cost of the financing before proceeding.
It's even more crucial to make sure that when you're comparing multiple offerings, all the fees are taken into consideration. Otherwise one lender's pre-approval might look really positive, only to become really expensive when you discover fees like success fees, line fees and more.
Extension Costs
This is also something to keep in mind. While we all like to think our projects will run to our projected timeframe, and even allow a little bit more time to make sure things are complete before the finance expires, there are times when that just doesn't happen.
So again, if you're looking at multiple lenders, look at what's going to be involved if you need to extend the loan. Will the lender require you to make a whole new application, with all the associated fees needing to be paid a second time? Or do they have a mechanism in place to negotiate an extension?
As a side note - if you find yourself in that situation, start negotiations early!
The bottom line is that a pre-approval is NOT a guarantee of finance, and even if the finance comes through, it may not be what you were expecting.
To navigate the potential pitfalls of finance pre-approvals effectively, it's essential to review the terms carefully, maintain accurate financial records, and regularly monitor your credit report. Additionally, seek guidance from an experienced broker to help you make the best choices in regards to finance.
