Loan Preapproval: A Smart Move for Buyers

Getting preapproved can make shopping a lot easier

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••• Francesca Cambi / Getty Images

It’s smart to get preapproved for a loan before you start shopping for big-ticket items like a mortgage or a car. Getting preapproved for a loan means that you know how much money a lender is willing to give you, at which rate, and on what terms. It’s a way to find out what kind of financing you’re qualified for before you go too far down the wrong path.

Preapproval involves submitting a preliminary application to a lender that will review your credit, your income, and other factors, while also telling you which loans are available to you. As a result, you can focus solely on loans that you’re likely to qualify for, while also having a better idea of which price ranges you should stay within.

There Is No Obligation

Just because you're preapproved doesn't necessarily mean you have to borrow that money. You’re just gathering information. If you find 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 loans can sometimes fall through.

You can reduce the chances of problems by making sure the loan-to-value ratio is acceptable to the lender. For home purchases, it may also be important for an appraiser to value the property value at a level that’s high enough for your ratios to work.

Make sure that lenders can verify your income and assets available to repay the loan. Gather paystubs and other details about your compensation, and be ready to provide account statements.

If you’re getting an auto loan, verify that any dealers you’re shopping with can work with the lender you've chosen.

Why Get Preapproved?

A preapproval offers several benefits to borrowers:

  • You know the numbers: The preapproval process helps you find out exactly how much you can borrow. Lenders review your finances and provide a realistic estimate given the offerings that are currently available. You can also run the numbers yourself using online calculators, but it’s best to get an official review from a lender, who 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. It can be risky to fall in love with something (a home or vehicle) that might be out of reach financially, since that might tempt you to stretch more than you should.
  • You can shop like a cash buyer: When you walk in preapproved, 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 lenders often quote attractive rates in advertisements, but not everyone can qualify for those rates. Lenders scrutinize your credit, income, and assets when you get preapproved, and they might also inquire 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 of this information.

Pre-qualification vs. Preapproval

Some lenders don’t distinguish between these two terms, and it might not matter what they call it. The essential thing is to have a lender examine your finances and tell you how your loan application looks. That said, pre-qualification is typically a more preliminary process, while preapproval requires a more in-depth examination of 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, and it’s worth the extra effort if you’re serious about buying. Whether you’re getting pre-qualification or preapproval, it means you’re making informed decisions about taking out a loan.  

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 in advance, leaving enough time to correct any errors or issues you might find there.
  • Gather your information: You typically need confirmation of your income through pay stubs, tax returns, W-2 forms, and Forms 1099, if applicable. Some lenders ask for bank statements as well, and you might have to confirm your identity by providing a driver's license or other ID.
  • Contact lenders: Select several lenders to get preapproved with. Include a variety of sources, including a local bank or credit union and an online lender. If you're working with a brick-and-mortar institution, you might be able to bring documents to an office. With online lenders, be prepared to upload documents for the lender to review.

It’s a good idea to compare offers from several lenders to find the best deal available. Doing so helps you begin the process of narrowing down your list of lenders. You only need one preapproval in place to say you're preapproved, but it may be helpful to get the ball rolling with multiple lenders.

Finding the Right Lender

Don't jump at the first lender who's willing to give you the money. Remember, you're not obligated to actually take the money if you get preapproved. Comparing offers helps you learn about various offerings as well as find out who has the most competitive pricing.

Be sure to complete all of your applications within a relatively short period of time (a month or so is best) to avoid having too many hard inquiries in your credit history.

Too many hard inquiries can damage your credit score. You can limit the damage by keeping your credit inquiries to a brief window of time, which signals that you’re shopping for the best loan. Credit scoring models may encourage this by treating multiple inquiries in a short timeframe as just one inquiry (for auto and home loans).

Be cautious with unsolicited offers you receive in the mail. Look into each lender thoroughly and research their practices. Have many others done business with them? If you notice warning signs in the information you find, you might want to steer clear. The same obviously applies if you discover that a lender has received a lot of negative reviews.

Increase Your Odds of Success

What if you get preapproved, only to realize that the dollar amount isn’t as much money as you’d like or need? Or worse, what if you’re denied preapproval entirely?

Start with the unpleasant task of considering whether you need to lower your expectations. Fortunately, you do have a few options in the event 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, likely increasing your potential loan amount and possibly even offering you a lower interest rate.
  • Make a larger down payment. This will reduce the amount you need to borrow, lowering the monthly payment.
  • Offer the lender more collateral (assets in your possession that protect the lender in case you can’t pay on your loan).
  • Apply for a longer-term loan, but be 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. Paying down your loan balances is one strategy to accomplish this.
  • Maintain your debt-to-income ratios. You don't want to upset the apple cart by immediately taking on more debt after a preapproval. Your credit information should 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." Lenders base their decisions, at least in part, on your credit history. The better your track record as a responsible borrower, the more likely it is that you'll be approved.

I was preapproved, but then denied. What happened? The culprit could be 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 expect an answer within a few days of your inquiry.

Article Sources

  1. Consumer Financial Protection Bureau. "Get a Prequalification or Preapproval Letter." Accessed Mar. 30, 2020.

  2. Experian. "Understanding Loan-to-Value Ratio (LTV)." Accessed April 5, 2020.

  3. Federal Deposit Insurance Corporation. "When Applying for Your First Mortgage, Loan Information Is Key." Accessed Mar. 30, 2020.

  4. Consumer Financial Protection Bureau. "What’s the Difference Between a Prequalification Letter and a Preapproval Letter?" Accessed Mar. 30, 2020.

  5. Consumer Financial Protection Bureau. "Learn to Explore Loan Choices." Accessed Mar. 30, 2020.

  6. Consumer Financial Protection Bureau. "Will a Lender Getting a Copy of My Credit Report Affect My Score?" Accessed Mar. 30, 2020.

  7. Consumer Financial Protection Bureau. "Why Might I Need a Co-Signer in Order to Get Vehicle Financing?" Accessed Mar. 30, 2020.