Pre-approval or pre-qualification: what's the difference?

In Canada the two words are not fixed terms. What decides your position is the credit check, the paperwork and a rate hold that runs 60 to 130 days.

Lenders use both words and neither is defined in law. The Financial Consumer Agency of Canada describes one process and says it may also be called mortgage prequalification or mortgage preauthorization, then adds that lenders set their own definitions for each step they offer. So the word at the top of the letter tells you very little. What the lender did to produce it tells you almost everything.

Is there a legal difference between pre-approval and pre-qualification?

No. Neither term is set out in legislation or fixed by a regulator, and the Financial Consumer Agency of Canada treats prequalification, preapproval and preauthorization as three names for the same lender process, noting that different lenders have different definitions and criteria for each step they offer.

Two buyers can hold letters with the same word on them and be in very different positions. A buyer with a pre-qualification from one lender can be further along than a buyer with a pre-approval from another. Comparing the words gets you nowhere. Asking which checks were actually run gets you a straight answer in about a minute.

What does a lender do when you get pre-approved?

They look at your finances, work out the maximum they may lend you and at what rate, and they will likely run a credit check. FCAC lists what they ask for: identification, proof of employment, proof you can pay for the down payment and closing costs, information about other assets such as a car, cottage or boat, and information about your debts and financial obligations.

Proof of employment usually means a recent pay stub showing your salary or hourly rate. If you work for yourself, FCAC says lenders ask for notices of assessment from the Canada Revenue Agency for the past two years.

This is where the real difference sits. A lender who has read your notices of assessment and pulled your credit knows something about you. A lender who has taken your word for your income has produced an estimate, whatever the letter calls it.

How long is the interest rate held?

60 to 130 days, depending on the lender, according to FCAC. That is a wide range, and the hold is the part of a pre-approval with money attached, so it is worth knowing which end of it you are on before you start looking.

Get the expiry date in writing, and ask what happens if you are still looking when it runs out.

What interest rate are you qualified at?

Not the one you were quoted. FCAC states that banks must use the higher of 5.25 per cent or the interest rate you negotiate with your lender plus 2 per cent. For uninsured mortgages at federally regulated lenders, the Office of the Superintendent of Financial Institutions sets its minimum qualifying rate the same way: the greater of the mortgage contract rate plus 2 per cent, or 5.25 per cent.

So a quoted rate of 4 per cent is tested at 6 per cent, and a quoted rate of 3 per cent is tested at 5.25 per cent, because the floor is then the higher of the two. The figure on your letter is the amount that survives that test, not the amount your quoted payment would support. We go through it in more detail in how the mortgage stress test works.

Two ratios sit behind the figure as well. FCAC puts monthly housing costs at no more than 39 per cent of gross household income, and total debt load at no more than 44 per cent.

OSFI adds one exception, and it applies at renewal rather than at purchase: it does not expect lenders to apply the minimum qualifying rate when a borrower switches an uninsured mortgage from one federally regulated lender to another with no increase to the amortization period or the loan amount.

Can a lender still say no after pre-approving you?

Yes. FCAC says a lender could refuse you for a mortgage even if you have been preapproved, and gives two reasons: the property has to meet certain standards, which vary from lender to lender, and your credit history.

A pre-approval is a view of you. The approval is a view of you and the property together, on the day. FCAC says the approved mortgage amount depends on the value of the property and the amount of your down payment, so a lender that values a home below the price you agreed will lend against its own figure, and the gap is yours to cover.

That is the mechanism a financing condition exists to handle. A pre-approval is not a substitute for one, and going in firm on the strength of a letter moves that risk onto you.

What is a pre-approval worth to a seller?

Less than it looks. A seller reading offers should treat a pre-approval letter as one input rather than as proof of funds, because the same agency that describes the process says it does not guarantee approval, and the approved amount turns on the property and the down payment.

The more useful questions for a seller are which lender issued it, when it expires, whether the buyer's credit was checked, and whether the offer carries a financing condition at all. If you are weighing offers on your own home, we set out how we read them on our selling page.

How much do you have to put down?

The minimums are federal and do not vary by lender. FCAC sets them out: 5 per cent of the purchase price at $500,000 or less; 5 per cent of the first $500,000 plus 10 per cent of the portion above it, between $500,000 and $1.5 million; and 20 per cent at $1.5 million or more.

Below 20 per cent you will normally need mortgage loan insurance, with premiums running 0.6 to 4.5 per cent of the mortgage amount.

The $1.5 million line is worth watching in Toronto, where a good number of freehold houses sit close to it. A home at $1.4 million can be bought with $115,000 down. The same home at $1.5 million needs $300,000, and insurance is not available above that line. Our affordability calculator runs the down payment and the qualifying rate through together.

What should you do before you apply?

Order your credit report and check it for errors before you start shopping around for a mortgage, says FCAC. Errors take time to correct, and it is better to find them before a lender does.

Then gather what the lender will ask for, so that what comes back is based on documents rather than on conversation: identification, pay stubs or two years of notices of assessment, proof of the down payment and closing costs, and a list of your debts.

What should you ask before you rely on it?

Five questions do more work than the word on the letter:

• Did you pull my credit, or is this based on what I told you?
• What rate is held, and until what date?
• What rate did you qualify me at?
• Is the amount conditional on the property, and what would change it?
• What should I tell you about between now and closing?

The last one catches more deals than the rest. A new car loan, a change of employer, or a credit card balance run up between the letter and the closing all land in the file the lender looks at again, and the letter protects you from none of them.

When you are ready to start looking, begin here.