Pre-qualification vs Pre-approval for Personal Loans
The terms pre-qualified and pre-approved are often confused with each other; however, they are essentially two distinct processes that can be very helpful to borrowers. Pre-qualified can be thought of as an initial, relatively informal examination, whereas pre-approved typically is an evaluation performed at a later time in the application process. Knowing the difference between these two will help you plan, compare loan options, and protect your credit.
What is pre-qualification?
Pre-qualifying is the first part of the process. You provide the lender with some general information regarding your income, housing expenses and banking habits. They will then run a soft credit inquiry to review your data. Soft inquiries do not affect your credit score. Pre-qualifying is similar to trying on a jacket at the mall. You can see if it fits before you purchase the jacket.
The pre-qualifying process provides you with an estimate. This may include the possible loan amount, monthly payment and interest rate options. The pre-qualifying process is not a guarantee that you will be approved for a loan. It gives you an idea as to whether the proposed terms are within your budget.
What is pre-approval?
Pre-approval requires much more validation, including your last 3 months’ pay stubs and your last 6 months’ bank statements. Even though many lenders will perform a soft inquiry at this point, some lenders may require a hard inquiry after you have agreed to their terms. Performing a hard inquiry can slightly lower your credit score for a very short period.
Pre-approval feels almost like an agreement, but pre-approval is really just the lender stating that, based on all of the information you provided, you qualify for a loan with them. Pre-approval is similar to having a reservation for a specific seat at a theater; your name is likely to be assigned to that seat, but the ticket has not been scanned.
What pre-qualification means for soft-check personal loans
Many lenders use income, deposits, and spending habits as alternatives to credit inquiries. In cases like this, the loan pre-qualification process typically gives you estimates of how much you will qualify for, with no impact on your FICO score. However, once you decide to take a step further in the application process, the lender may ask for documentation that supports everything you have given them so they can confirm you can afford the monthly payment.
Using this route is beneficial for people who are considered a “thin file” applicant (you don’t have enough credit history) or have had late payments in the past. This way, you can research your options without creating multiple layers of hard pulls on your credit report. Also, you can get an idea of your monthly payments before you commit.
How to read what you are offered
When reviewing what has been offered to you, you need to look at the four main components of your offer:
- The amount of money that you can borrow.
- The length of time you are going to take to repay the loan.
- The amount of money that you will be paying per month (your payment).
- The total you will owe for the loan – covers all the extra costs and the interest.
If any part of the offer seems too tight, stop and recalculate. A relatively short extension of the term of the loan can result in a significantly different monthly payment.
A simple example
You complete an online pre-qualification process to determine if a possible $800 loan is available to you with a six-month loan term. The online pre-qualification process provides a monthly loan repayment amount that should fit into your budget. You will need to upload a copy of a recent pay stub and a recent bank statement to receive pre-approval from the lender.
When the lender reviews your pay stub and bank statements, they verify that your income and deposits match what you stated on your application. The lender’s final offer is very similar to their initial estimate. Since you completed the initial steps of the pre-qualification process through a soft credit check, your credit score remains unchanged throughout the process until the lender completes the final approval.
Common questions
Is pre-qualification binding?
No. It is an estimate based on basic info and a soft check. Terms can change after documents are reviewed.
Will pre-approval lock my rate?
Not always. Some lenders lock a rate for a short window after pre-approval. Others lock only after you sign. Read the timing in the disclosure.
Can I get denied after pre-approval?
If your documentation does not match what was used to provide a pre-approval, for example there could be a change in your income or because lending regulations require that the lender make a different determination, then a denial can occur. By keeping your financial data updated and truthful, the possibility of having a surprise at closing can be reduced.
Do I need both steps?
Generally, yes. Getting pre-qualified helps you compare options when you’re looking around. And pre-approval gets all the specifics sorted out, which makes the final approval process quicker.
Smart steps to stay in control
Start by getting pre-qualified; that way, you can shop around without being dinged for a credit check. Keep all your recent pay stubs and bank statements available in case you need to get pre-approved. Ask about the type of pull used for each step (soft inquiry vs. hard pull), and document it on the disclosure. Only move to the final step when the numbers fit your budget with room to breathe.
Bottom line
Pre-qualifying is an initial soft look at what may be possible. Pre-approving is the final review of the details to ensure everything is in place for your loan. Both pre-qualifying and pre-approving help you get a better idea of the options available to you. It helps reduce the number of hard credit pulls on your account and allows you to select a monthly payment you can afford. It is similar to creating a map for your trip before actually driving. Completing a few smart actions today can save you stress later.
References
https://www.investopedia.com/articles/basics/07/prequalified-approved.asp
https://www.experian.com/blogs/ask-experian/pre-approved-vs-pre-qualified-whats-the-difference