If you've never applied for and received a loan before, there are quite a few terms in the process that might cause some confusion. Understanding these terms can help you avoid misunderstandings and find the best loan options with as little effort as possible. While "pre-approval" and "pre-qualification" are sometimes used interchangeably by the public, they differ. Here's what you need to know about the differences between pre-approval and pre-qualification. Plus, you'll learn why these terms matter in the larger scheme.
The first thing to know is that both terms are good for you. However, they are good in different ways, and one way offers more benefits than the other.
Pre-Qualification
Pre-qualification is a process in which you provide lenders with specific
information about yourself and your financial situation to understand roughly how much lenders are willing to offer you. This can be highly beneficial when considering applying for a mortgage as it provides a ballpark figure related to how much you could borrow based on the information you've provided.
This process involves a soft inquiry on your credit report that doesn't negatively impact your score. However, it relies on the accuracy and integrity of your answers about income, debt, and assets. For the most part, this is the first step to consider if you're interested in buying a home, and it can reveal things you want to work on before taking things to the next level.
At the end of the day, pre-qualification does not guarantee approval for a loan, nor does it create any obligations or expectations on the lender's part either. It only hints at your ultimate readiness to apply for a loan and an idea of how much money lenders might agree to lend you in your current situation.
Pre-Approval
The pre-approval process involves a more in-depth look at your financial and credit situation. It involves a hard inquiry into your credit report and concrete evidence to support financial claims. This includes:
- Check stubs.
- W-2s.
- A summary of assets.
- An accounting of debt.
It is important to note that multiple hard inquiries within a short period (typically 14 to 45 days, depending on the scoring model) for the same type of loan are usually treated as a single inquiry. This means that shopping for a mortgage within a specific time frame will not hurt your credit score as much as multiple hard inquiries spread over a more extended period.
A pre-approval for a loan is more likely to result in a loan offer though it makes no guarantee until you go through the actual loan application process. Because lenders have investigated your income, credit history, debt-to-income ratio, credit utilization score, and much more, they are better able if they are willing to lend to you and a specific dollar amount they may be helpful to offer. If you're interested in buying a home, this is instrumental for budgeting and keeping your home search within your price range. A pre-approval letter is also something more buyers are looking for when considering offers.
The Pre-Approval and Pre-Qualification Process
So, what is involved in each process, and how are they different? It's an excellent question, and here's what you need to know.
The pre-qualification process is less invasive from a credit history point of view. These information types are used to pre-qualify buyers for mortgage (or other) loans.
- Estimates current debt, income, assets, and credit score.
- A soft credit inquiry.
- Available at no cost to consumers.
- No mortgage application or down payment estimate is necessary.
- Does not guarantee loan approval.
- Provides results in minutes (or sooner).
You also get different results from a pre-qualification than from a pre-approval. Remember when applying and take the results with a grain of salt.
The pre-approval process is a little longer and more involved. However, you'll get a more definitive answer about whether you qualify for a loan and how much a lender is willing to offer. Here's what you need to provide for the pre-approval process.
- A hard credit inquiry.
- A lengthy application process may take 30 or more minutes to complete.
- A longer response time—it may take days to get an answer.
- Requires down payment estimate.
- Delivers specific loan amount and interest rate information in results.
While you aren't guaranteed a loan offer when you go through the pre-approval process, you have a better idea of where you stand. More importantly, it can give you an idea of whether you might be better served to wait until you have a higher credit score or a larger down payment before buying a home.
Pros and Cons of Pre-Approval and Pre-Qualification
There are a few pros and cons to consider for pre-qualifications and pre-approvals. For instance, pre-qualification is quick and painless without leaving a hard mark on your credit report, and it can be completed in a matter of minutes with results equally fast. Unfortunately, the results aren't as informative as you'll receive with a pre-approval. Sellers don't put as much stock in a pre-qualification letter that offers no idea of how much banks are willing to provide as they do for a pre-approval.
The pros and cons of pre-approvals are simple as well. First, sellers love these as they are confident you can back up an offer with sufficient financing (because it provides a dollar amount). Additionally, you have a better idea of what you can afford because it offers information on interest rates. The downside is that you must endure a hard inquiry on your credit report, which can reduce your score, and that it still does not guarantee you'll ultimately get the financing you seek.
One thing to note is that these processes are not binding on either the borrower or the lender. Even if you are pre-approved, the lender can still deny your loan application based on further information or changes in your financial situation. Similarly, you are not obligated to take a loan from the lender that pre-approves you. Also, pre-approval letters usually have an expiration date, typically around 60 to 90 days. If you do not find a property and secure a loan within that time frame, you might need to go through the pre-approval process again.
How Pre-Approval and Pre-Qualification Affect Loan Applications
The most significant way these processes affect loan applications is when you seek pre-approval, it can cause a slight dip in your credit score. However, some lenders will overlook that as part of the home-buying process. The benefits pre-approvals offer far outweigh the potential drawbacks for many people interested in buying a home. The pre-qualification process can provide important insights concerning your readiness to take the next step.