Loan Preapproval: A Smart Move for Buyers
Getting preapproved can make shopping a lot easier
It’s sound advice to get preapproved for a loan before you start shopping for a big-ticket item like a mortgage or auto. Getting preapproved for a loan means that you know how much money a lender is willing to give you, at what rate, and at what terms. It’s a way to find out whether you can get financing before you get your hopes up.
Preapproval involves submitting a preliminary application to a lender that will then review your credit, your income, and other factors, and tell you what loans are available to you.
There's No Obligation
You don't necessarily have to borrow money when you get preapproved. You’re just gathering information. If you get a better offer from another lender, you can take it.
Likewise, the lender might not actually make a loan that you've been preapproved for. There shouldn't be any problems if you and the lender have been thorough in the preapproval process, but the loan can fall through in some cases.
You can avoid that by making sure the loan-to-value ratio is acceptable to the lender. This means the lender agrees that the property is worth as much as you think it’s worth, and an appraiser concurs.
Make sure that all details about your income and assets can be verified, if they haven't been already.
And you must typically purchase from a dealer that can work with the lender you've chosen if you're looking into an auto loan.
Why Get Preapproved?
A preapproval offers numerous benefits and advantages:
- You'll 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 that are currently available. You can also run the numbers yourself using online calculators, but it’s even better to get preapproved and have a lender review everything—they might spot something important that you've overlooked.
- You'll stay focused: You can narrow down the universe of possibilities when you know how much you can borrow. You'll only shop for what you know you can actually afford to buy. You'll avoid falling in love with something that might be out of reach financially—and that might tempt you to stretch more than you should.
- You can shop like a cash buyer: You don’t have 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 and when you decide to buy.
- You'll understand the costs involved: Credit unions, auto dealers, traditional banks, and online lender often quote attractive rates in advertisements, but you might not qualify for those rates. Lenders review your credit, income, and assets when you're preapproved, and they might also ask about the property you’re going to buy. For example, is it a new or used car, a single-family home, or a condo? They can provide a quote that’s realistic for you and your situation when they're armed with all this information.
Pre-qualification vs. Preapproval
Some lenders use these terms interchangeably, and it might not matter what they call it because the most important thing is to have a lender examine your finances and tell you how your loan application looks. That said, pre-qualification is just a preliminary process, while preapproval requires a more detailed look into your finances.
Again, neither preapproval nor pre-qualification guarantees that you’ll eventually qualify for the loan, but preapproval is more likely to identify problems that you aren’t aware of. It’s worth the extra work if you’re serious about buying.
How to Get Preapproved
You're basically applying for a loan before you actually need the money when you seek preapproval, and the steps are largely the same.
- Check your credit: Make sure your credit is up to the task. Pull your credit reports and leave enough time to correct any errors or issues you might find there.
- Gather your information: At a minimum, you'll need confirmation of your income through paystubs, tax returns, W-2 forms, and Forms 1099, if applicable. Some lenders will require bank statements as well, and you might have to confirm that you are who you say you are by providing a driver's license or other ID.
Finding the Right Lender
Don't jump at the first lender who's willing to give you the money. Compare several to find the best deal for you. You might even want to apply to a few good ones—remember, you're not obligated to actually take the money. Just be sure to make all your applications within a relatively short period of time, no more than a month. All these lenders will pull your credit report, and this activity shows up there. Too many inquiries can hurt your credit score unless it's clear that you're shopping for the best loan because all these hits are coming at roughly the same time.
Be careful with unsolicited offers you receive in the mail. Look into each lender thoroughly. Check their reputations online. Have many others done business with them? If not, you might want to steer clear. The same obviously applies if a lender has a lot of negative reviews.
Increase Your Odds for Success
What if you get preapproved only to realize that it's not for as much money as you’d like or need? Or worse, what if you're not preapproved at all?
Start with the unpleasant task of considering whether to lower your expectations, but you do have a few options if you find that you really need to borrow more.
- Increase your available income by applying for the loan jointly with a spouse or co-owner, or consider a cosigner. The lender will take both incomes into account.
- Make a larger down payment. This will reduce the amount of your loan and lower the monthly payment.
- Offer the lender more collateral.
- Apply for a longer-term loan, but beware of interest costs and the possibility of getting upside down.
- Work on building or improving your credit so you're more attractive as a borrower.
- Maintain your debt-to-income ratio. You don't want to upset the apple cart by immediately taking on more debt after your preapproval. You want your credit information to remain the same from the time of your preapproval to the time you actually take out the loan. Remember, preapproval is not a guarantee. It can be pulled at the last minute if something changes.
Frequently Asked Questions
How important is my credit? In a word, "very." All lenders of all loans base their decisions at least in part on your credit history. The better your track record with borrowing, the more likely it is that you'll be approved.
I was preapproved, but then denied. What happened? The culprit is usually a significant change in your financial situation, such as a job change or job loss, or large purchases and credit commitments after preapproval. It's also possible that the lender's qualifying criteria have changed.
How long does the approval process take? You should have an answer within about a week.