Approval in Principle vs. Pre-Approval.

Much like ordering everything off the menu at a Michelin star restaurant without checking your wallet, searching for properties without understanding your true borrowing power can leave you with a bill that you can’t afford (or get out of).

Whether you’re a first-home buyer or looking to upsize or downsize, speaking to a lender should always be your number one priority. They’ll help you estimate your borrowing power so you can search, bid and buy with greater confidence that a loan will be approved.

There are many steps to the house hunting and buying process. But before you start browsing on your favourite real estate site, you’ll need to know what to set the price filters to. Calculating your borrowing power (also known as a Borrowing Capacity Estimate) – an estimate of what you could afford to borrow based on your current income and existing financial commitments – will help you search for properties within your budget.

What’s a borrowing capacity estimate?

As the name suggests, your borrowing capacity estimate will let you know what you could potentially borrow so you can begin the search and start looking online.

Despite confusion, this estimate is not a legally binding document and there is no guarantee you’ll be approved for a loan or for that amount. In fact, Borrowing Capacity Estimates are not financially assessed by the lender and haven’t been to their credit department – they’re not fit for bidding.

So, why get a borrowing capacity estimate before approval?

There’s no point looking at mansions if you can only afford a unit. An estimate will give you an approximate figure of how much you could borrow so you can begin your journey.

Successfully winning at auction with pre-approval only is extremely risky business. If you can’t get a loan approved in time – or at all – you’ll lose your 10% deposit.

What’s approval in principle?

Approval in principle (AIP) is the first step to getting an approved home loan – it’ll also help you be seen as a more serious buyer, which is a massive plus when you could be up against some serious competition.

Applying for approval in principle is free and should be done when you have an idea of how much you want to borrow, where you want to buy, what type of property you would like to buy and when you’re ready to buy. It’ll help you determine your budget, repayments and the type of properties you should be looking at (e.g. apartments or stand-alone houses).

And unlike pre-approval, approval in principle (AIP) requires a full credit assessment and responsible lending assessment. A lender will look at your requirements and objectives, along with your current financial situation and will ask:

• Who you are? You’ll need to provide formal proof of ID.
• How much you earn? This includes your salary, investments or rental income.
• How much you own? The lender will evaluate all of your assets, including cars, jewellery, shares and savings.
• Do you owe money? From a car lease to credit cards, you’ll need to declare any debt or loans you currently have.
• What are your living costs? The lender will look at your monthly expenses groceries, bills, transport and lifestyle to help estimate your loan.
• What type of properties you’re looking at? The lender will need to know the suburbs you’re looking at, property type and size to ensure it’s a good investment for them too.

Does approval in principle mean I’m approved?

Put simply, no. There is never a 100% guarantee you’ll be approved by a lender. But providing your financial circumstances haven’t changed and you bought a similar style and priced property to the ones your loan is based on (and in the same or close suburb), there’s a better chance you’ll be approved.

To obtain formal approval after winning at auction, the lender will need to see:

• The property you purchased. The lender may get the property valued and determine if it meets its Loan to Value Ratio (LVR) requirements.
• The contract of sale. The lender will need specific information about the property you bought, including outgoings, permits, zoning and previous works.

Will it expire?

Approval in principle is only valid for 120 days (or 90 days if you are refinancing), so if your circumstances change, you get a new job or even a promotion, you must let your lender know – it could hugely impact your potential borrowing power.

Buying your first home, upsizing or downsizing are always exciting moments in life. Before you start the search, always engage with a lender to ensure you’re financially stable and your application is low risk. Failing to do so could leave you severely out of pocket.

So, if you’re looking for a home, let a ME home loan specialist or your broker help you with the paperwork and the loan approval process.