Ensuring Clients Understand the Risks of Pre-Approvals

Alberta’s competitive real estate market has recently seen some consumers relying on pre-approvals to make offers without a financing condition. While this strategy can strengthen a buyer’s position in a competitive situation, it also comes with significant risks that your home buyer clients need to be made aware of.

The Growing Trend of Pre-Approval Reliance

In markets with rising demand and limited inventory, buyers are often motivated to present the most attractive offer possible. Your clients may feel it advantageous to use their pre-approval status to submit offers without a financing condition. You or your clients may suggest using this approach to make offers more appealing to sellers, who might prefer a deal with fewer conditions. Unfortunately, we have seen a growing number of deals collapsing and deposits being forfeited in situations where a financing condition has been waived. We believe this is because many consumers do not understand what a pre-approval entails.

Pre-Approval Offers No Guarantees

Mortgage brokers and real estate licensees should be clear with their clients that a pre-approval does not guarantee that their final loan will be approved.

Deals can and have fallen apart where a buyer had a pre-approval, but their final financing could not be secured. Please ensure you are explaining the realities of a pre-approval to your client, so that there are no misunderstandings.

Differences in Pre-Approval Processes

Pre-approval processes can vary significantly depending on the mortgage broker. Some brokers provide a simple rate hold, while others conduct a more thorough pre-approval, involving document collection and preliminary underwriting. Regardless of the approach, there are inherent risks that your clients need to understand.

Their final loan approval depends on multiple factors including:

Property-Specific Considerations: the ultimate approval of a mortgage relies not just on the borrower’s qualifications but also on the specific property being purchased, which is unknown at the pre-approval stage. The property itself must meet certain criteria, and its value must be validated by the lender. Buyers should be aware that an offer above market value may not be supported by an appraisal when they apply for the mortgage loan. If they have placed an unconditional offer, they will need to have access to extra funds to increase the downpayment for any amount that exceeds appraised value.

Changes in Buyer’s Financial Position: Any changes to the borrower’s financial situation between the time of pre-approval and the final offer can significantly impact the lender’s decision. This includes changes in employment, income, debt levels, or even the borrower’s credit score.

Mortgage Brokers and Consumer Education

While mortgage brokers are aware of the tentative nature of pre-approvals, this understanding is not always successfully communicated to consumers. As a mortgage broker, you need to ensure that your clients fully understand the limitations of their pre-approval and the risks involved in making an offer without a financing condition if they choose to do so.

In a competitive market, the pressure to present an attractive offer can be strong, but it should not come at the cost of financial security. Clients need to be reminded of the multiple factors that may affected their pre-approval so that they can protect themselves from any disappointment or financial loss that could arise from a failed deal.

It is RECA’s duty to protect both consumers and the integrity of the real estate industry. Ensuring your clients are fully informed of the risks of a mortgage pre-approval accomplishes both goals and ultimately ensures but industry and consumer interests are protected.

As an extra means to ensure your clients understand the decision, and to protect yourself in the event of a dispute, documenting your discussion is advised.

If you are a broker or broker delegate and have any questions about pre-approvals or regulatory related mortgage advice , please reach out to gsiegle@reca.ca.