Loan Preapproval: A Smart Move for Buyers
It’s sound advice to get preapproved for a loan before you start shopping. But what does that mean, and why is it important?
What it Means to Get Preapproved
When you get preapproved, you submit a preliminary application to a lender. They review your credit, income, and other factors, and tell you what loans are available to you. Getting preapproved helps you find out how much a lender will give you, at what rate, and what the terms look like. It’s a way to find out—before the last minute—whether or not you can get financing.
You do not necessarily have to borrow money when you get preapproved. You’re just gathering information and bargaining power. If you get a better offer from another lender, you can take it. Likewise, the lender may not actually make a loan you’re preapproved for. If you and the lender have been thorough in the preapproval process, there shouldn’t be any problems. But in some cases, the loan process can fall through. Be sure that:
- The loan to value ratio is acceptable to the lender, and the lender agrees that the property is worth as much as you think it’s worth, and an appraiser concurs.
- Details about your income and assets can be verified (if they weren’t already).
- With an auto loan, you purchase from a dealer that can work with the lender.
Why Get Preapproved?
Know the numbers: The preapproval process helps you find out exactly how much you can borrow. Lenders run the numbers and provide a realistic estimate given the products currently available. You can also run numbers yourself using online calculators, but it’s even better to get preapproved and have a lender review everything—they may spot something important. They know their policies, and other lenders are likely to have similar programs.
Stay focused: When you know how much you can borrow, you narrow down the universe of possibilities so that you only shop for what you can actually afford. You can avoid falling in love with something that may be out of reach financially (and that may tempt you to stretch more than you should).
Shop like a cash buyer: Once you’re preapproved, you don’t need to line up financing at an auto dealer or tell a home seller that you haven’t yet talked to a lender. You and the seller can be reasonably confident that the money will be there if you decide to buy.
Understand the costs: Lenders (whether it’s a credit union, auto dealer, traditional bank, or online lender) often quote attractive rates in advertisements. But you might not qualify for those rates. When you get preapproved, lenders review your credit, income, and assets. They may also ask about the property you’re going to buy (for example, a new or used car, a single-family home or a condo). With that information, they can provide a quote that’s realistic for you and your situation.
If You Come Up Short
What if you get preapproved and you cannot borrow as much as you’d like? Start with the unpleasant task of considering whether or not to lower your expectations. If you find that you really need to borrow more, you have several options:
- Increase the income lenders consider by applying for the loan jointly (with a spouse or co-owner, for example).
- Make a larger down payment (which reduces the amount of your loan, and lowers the monthly payment).
- Offer more collateral to the lender.
- Use a co-signer.
- Use a longer-term loan (but beware of interest costs and getting upside-down).
- Work on building your credit to appear more attractive as a borrower.
Pre-qualification vs. Preapproval
Pre-qualification and preapproval both help you learn important details from lenders, such as how much you can spend, and what interest rates you might qualify for. But pre-qualification is a preliminary process, while preapproval requires a more detailed review of your finances. To get preapproved, lenders typically pull your credit and look at documentation regarding your income and assets.
Again, neither preapproval nor pre-qualification guarantees that you’ll eventually qualify for a loan. But preapproval is more likely to identify problems that you aren’t aware of, so it’s worth the extra work if you’re serious about buying.
Some lenders use the terms interchangeably, and it might not matter what they call it. The most important thing is to have a lender examine your finances and tell you how your loan application might look.