When borrowers first think about applying for a new loan, it may be hard to estimate exactly what kinds of loans or rates they could qualify for, or to compare the loans that might be available to them.
Before going ahead and deciding to apply for a loan, borrowers could seek out preapprovals or prequalifications.
What is prequalification vs. preapproval?
Prequalification and preapproval are both terms for getting a preliminary approval on a loan prior to formally applying for it. These are great tools for comparing loans as well as figuring out whether or not a loan is the right fit.
Prequalification and preapproval aren't terms with industry standard definitions, and some lenders may use one or the other. Research each lender's specific terms around prequalification and preapproval to find out how their process works.
Why are prequalifications and preapprovals important?
Prequalifications and preapprovals have many of the same benefits as a full loan offer without the key drawback of potentially leading to credit damage.
Hard vs. soft credit checks
When seeking out a loan, borrowers will typically want to keep their credit score in the best shape possible. However, applying for most financial products including loans, credit cards or even job or rental applications may lead to what's known as a "hard credit pull." This is a formal request by the creditor to a credit bureau to look at your credit file.
A single hard credit inquiry doesn't have a large impact on a credit score. It could cause a small drop of about five points. However, multiple hard credit checks within a short period of time can lead to a credit score decrease.
That's because those small dips will add up, as well as the fact that lenders will see the history of inquiry and it may be a red flag that a borrower is taking out too much credit in a short period of time.
The benefits of prequalifications
People may have experienced preapproval most commonly in the form of a credit card offer received in the mail advertising that they've already been approved for a new card.
Preapproval or prequalification can be based on a soft credit check — which means it isn't associated with a specific application for additional credit by the borrower. That's how people can be preapproved for a credit card without even applying.
A soft credit check won't trigger the same credit dip but can give the lender an assessment of a borrower's creditworthiness, helping them estimate what kinds of loans and rates they might qualify for.
Are prequalifications or preapprovals the same as approvals?
Prequalifications and preapprovals are not the same as approval for a loan. These agreements aren't binding, and full approval will still likely require an application where the borrower will submit more documentation verifying their financial background, as well as a hard credit inquiry.
Being straightforward and transparent with a lender during the prequalification process will help ensure that applications can move smoothly from prequalification to full approval.
Notice: Information provided in this article is for informational purposes only. Consult your financial advisor about your financial circumstances.
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Original Source: How to Qualify for a Loan Before Applying
