Loans are vital financial products that give consumers enough capital to make expensive purchases they couldn’t have made with their own bank accounts. So whether you need a mortgage to buy your dream home or an auto loan, or you’re shopping for a new credit card, you’ll need to see if you can get approved. This is where prequalification comes in. Prequalification is a great way to determine your chances of getting approved for a loan or a credit card.
You’re probably asking yourself, “Does prequalification affect credit score?” The short answer is no. So read on to learn more about getting prequalified and ways to improve your credit score to increase your loan approval odds.
What is Prequalification?
A prequalification is an estimate of how much loan or credit you can get from a lender. To get prequalified, you need to submit an online prequalification form through the lender’s website. You’ll also need to provide your personal information, including name, address, Social Security number, employment status, current income, and debt.
The lender will use the information to decide whether you prequalify or not. If you meet the requirements, you’ll likely receive a prequalification letter via email. You’ll then determine if you want to move forward with the loan application. It’s important to note that lenders don’t verify information during the prequalification stage.
How Do You Get Prequalified?
Prequalification is a great initial step toward securing a loan or credit. The prequalification process varies by lender but generally follows a systematic procedure. You can expect the lender to as some of your basic information and your current financial situation.
Understanding your finances will help the lender determine your risk as a borrower and how much you can prequalify. Many lenders offer prequalification tools on their websites. All you need to do is enter your personal information, which will be used to determine which credit cards or loan products you’re eligible for. In addition, some online tools generate prequalification offers in a matter of minutes.
Prequalification vs. Preapproval: Is There a Difference?
The terms “prequalification” and “preapproval” are often used interchangeably by borrowers. However, while they might seem one and the same, they are different.
A prequalification is a non-verified estimate of how much you can get if you submit a loan application. The lender collects your basic financial information to gauge the amount they can loan you. Getting prequalified gives you a rough idea of how much you’ll likely be approved when you apply.
On the other hand, preapproval is a more professional step, where the lender verifies your financial information and credit history in order to approve your loan or credit card. Documents required for approval often vary by lender but may include pay stubs, tax returns, and even your Social Security card. After the process, you’ll receive a preapproval letter that contains the loan size and the interest rate you can get from your lender.
How Does Prequalification Affect Your Credit Score?
There are two common types of credit inquiries that creditors run when evaluating borrowers’ eligibility: a soft inquiry and a hard inquiry.
A soft credit inquiry, run at the prequalification stage, does not affect credit scores. This is because lenders sometimes base prequalifications only on the data on the first application, and some don’t even run credit checks. But if a creditor runs your credit, it will appear as a soft credit inquiry on your report.
When you apply for a loan or credit card, a hard credit inquiry, also referred to as a hard credit check, is run on your report. This type of credit inquiry is made during the preapproval and approval process to evaluate your credit risk.
Hard inquiries will have a negative effect on your credit scores, however, temporarily. Since hard credit inquiries affect credit scores, being preapproved and proceeding to apply for a home loan or other financial product may lower your score by a few points. Preapproval does not result in a hard credit inquiry, but if you apply for the preapproved loan, the hard credit check then takes place.
Does Prequalification or Preapproval Guarantee That You Get the Loan?
Getting prequalified does not affect your credit score, and the initial preapproval process doesn’t hurt you either. However, you only receive a hard credit check once you apply for the loan that you get prequalified or preapproved for. So a preapproval carries more weight, but it still doesn’t guarantee that you get the loan.
A borrower’s financials can change between receiving a preapproval and applying for a mortgage. That’s why a preapproval letter expires in 60-90 days. If the borrower takes out a personal loan after getting preapproved for a home loan, the preapproval doesn’t guarantee anything. Even if you don’t take out any loans within 60 to 90 days and apply for a loan, preapproval doesn’t guarantee approval. However, preapproval significantly increases your chances of getting a loan and can help you gauge how much capital to request during your application.
Ways To Get Your Credit Score Ready to Get Approved for a Loan
If you’re looking to get a loan or credit card in the next few months, consider working on your credit score. This way, you can increase your odds of approval. Here’s how you can get your credit score ready for loan approval.
Review Your Credit Score
The first thing you need to do is to check where your credit score stands. There are several free credit scoring websites, but make sure you read the fine print of the terms before you sign up. You can also check with your credit card issuer or lender if you already have one.
In addition, review your credit report to see what’s lowering your scores. Late payments and collection accounts can significantly impact your credit score, so try your best to make on-time payments to improve your score.
One more thing to look for in your credit report is errors. Mistakes happen, and your credit report is no exception. If you find an error, you can dispute it and have it removed from your credit report before you apply for a loan.
Pay Off Your Balances
If you have credit card balances, consider paying them down ahead of your application. Your credit utilization, an important credit scoring factor, measures the amount of revolving credit you’ve remained with. Paying revolving balances like credit card debt can lower your credit utilization ratio, thus helping your score. Making the minimum monthly payment will keep you in good standing, but letting debt linger will also result in an accumulating balance due to the interest rate.
Not only does paying off your balance improve your credit score, but it also helps with your debt-to-income ratio. This ratio helps mortgage lenders and others assess your ability to manage new debt, and you will need a low DTI to obtain a mortgage loan. You can lower that ratio by making more money, paying off debt, and using loans with more years on them if it’s necessary to get financing for something else before purchasing a home.
Avoid Opening New Accounts
Applying for a new loan or opening several credit cards can hurt your credit score. It’s not detrimental, as a hard credit check only lowers your score by a few points. However, if you apply for too many financial products that run hard checks, your score can take a hit.
The only situation where opening new accounts will help you build credit is if you’re making on-time payments. If you don’t have a credit card, you could start with a secured credit card if you have low credit. A credit builder loan is another good idea for people building credit. Otherwise, opening new accounts and missing payments can take a toll on your scores. Generally speaking, steer clear of opening new accounts months leading to your loan or credit card application. Even after you get a mortgage preapproval — something that doesn’t affect your credit score unless you decide to apply for a mortgage afterward — it’s best to avoid getting additional loans or lines of credit before applying for a mortgage.
Pay Your Bills Early
Late payments will hurt your credit score. Remember, lenders always want to see if you can make your monthly payments on time, so make sure you pay your bills early to increase your chances of approval. It’s the reason payment history makes up 35% of your credit score, a higher percentage than any other category.
Falling behind on payments will hurt your credit score, and a higher debt can make it more difficult to fulfill the debt-to-income ratio requirement. If you tend to forget, you may want to set automatic payments or reminders when your bills are almost due. You can set reminders on your phone or computer to show up a week before the bill is due.
