What is Preapproval? How The Process Works in Lending and Credit Card Applications

What Is Preapproval

Have you ever been denied a loan or credit card, and then you saw the denied inquiry on your credit report after the fact? Preapproval could have helped prevent that. Preapproval is a good sign you’ll be approved before you apply, helping to avoid the negative effects of denial.

Preapproval is when a lender takes a sneak peek at your credit, aka a soft inquiry that doesn’t affect your credit, basically giving a heads-up on whether you’re worth its while before you apply for a loan or credit card. 

Preapproval doesn’t ding your credit score. Instead, it gives you a friendly guess regarding what you may qualify for.

I’ll explain how preapproval works for credit cards, auto loans, and mortgages, how it’s different from prequalification, and discuss some common misconceptions that seem to cloud the process.

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The Basics of Preapproval 

Here I’ll cover the preapproval mechanism and its three facets: initial inquiry with a credit check, documents required with information, and how preapprovals differ for various financing types.

You’ll get a pretty fair idea of how preapproval works and how it fits into your financial planning, no matter how confusing it might initially seem.

Initial Inquiry and Credit Check

Preapproval starts with a soft inquiry on your credit report initiated by the lender. It’s similar to the lender peeping through the keyhole just to see if you’re worth allowing in.

The issuer or lender investigates your credit rating, debt-to-income ratio, and other bits of data about your financial condition. The credit bureaus provide the information without impacting your credit score.   Think of this as an innocent look-see — creditors get the information that they need, and your score remains intact.

Because the original credit search is a soft inquiry, it does not hurt or lower your credit score. You can make the rounds and collect plenty of preapprovals from various lenders. On the other hand, things get more serious once you decide to submit a formal application based on a preapproval quote because you’ll be subject to a hard inquiry (or hard pull). 

Hard InquiriesSoft Inquiries
Visible to anyone who pulls your credit reportsNot visible to others who check your credit
Can impact your credit scores for up to one yearWon’t impact your credit scores at all
Requires your authorizationDoes not require your authorization

Hard inquiries occur when the lender verifies your credit with a copy of one or more of your credit reports. Unlike soft inquiries, hard inquiries are recorded in your credit report and may drop your credit score a few points. 

Several hard inquiries within a very short period add to the impact on your credit score. That’s because all those piled-up applications make you appear to be in financial distress, regardless of whether you actually are or not.

Documentation and Information Required

In order to get preapproved, the lender requires some documentation to verify you’re a safe bet. It’ll want to check:

You’ll need to prove a stable income through pay stubs, tax returns, and maybe an employment verification letter from your boss. This information provides the creditor with evidence that you are capable of paying it back, so there’s no need for it to chase after you later on.

You’ll likely need to show other documents, such as a driver’s license or passport, to identify yourself. Once you prove you are who you say you are, the lender will take a hard look at your credit history. In particular, it’ll check your past loans, repayment history, and any debt you are dragging around. 

Preapproval Processes for Different Financing Types

To add to the confusion, preapproval procedures work differently for various financing options. Each category comes with its own set of rules, so your experience depends on what kind of financing you’re looking to get.

Credit Cards

When you preapply for a credit card, the issuer acts the part of a nosy neighbor by looking into your credit history. It may consider your credit score, payment history, current loans outstanding, and other factors to determine whether you are someone it can trust. 

A clean, no-nonsense credit report may get you that shiny new credit card, but if those late payments or loans start piling up, the issuer may want to hold off on giving you the green light.

The issuer will take your income into account to ensure you have enough to pay your credit card bill each month. It may want to see recent pay stubs or your tax returns to see what kind of money you’re pulling in. In short, the issuer ensures you aren’t taking on more than you can chew.

Based on this preapproval check and how much dough you’re bringing home, the lender may have already lined up how much credit you’ll get and at what interest rate. Your credit limit defines the amount the issuer will let you charge on the card, while the interest rate tells you how much you will be charged for the money you borrow.

But if the lender finds some skeletons in your closet during a hard inquiry, these numbers may change — or your application could be rejected outright.

Chart showing how to build payment history with a credit card.
Build a strong payment history by following these tips.

The offer terms give you a clear sense of your potential for credit card approval. You then must decide whether to make a formal application and experience a hard credit pull. 

Mortgages

The mortgage preapproval process is a whole ‘nother ballgame because the lender will do more than just peek under the hood — it will likely perform a hard credit check. It’ll consider your credit scores, repayment patterns, outstanding loans, and past borrowing. A good credit record may help with your interest rates. On the other hand, negative issues in your credit report may throw a monkey wrench into the proceedings.

Besides credit history, a mortgage lender requires all the details about your income and your assets. You’ll have to fork over pay stubs, tax returns, bank statements, proof of employment stability, the amount of income you earn, and the value of your assets. This information must prove you are capable of meeting the lender’s borrowing rules.

The lender will preapprove a loan amount for you after combing through your financial background. If everything checks out, the lender will set the maximum amount you can borrow and a budget that guides your home search. After all, you don’t want to waste everyone’s time looking at mansions when your budget can barely cover a log cabin.

A preapproval offer includes:

  • Interest rates
  • Loan type
  • Repayment period

A preapproval shows home sellers that you are serious, qualified, and vetted. This helps smooth the rails by making it clear what you can afford and enabling you to grab a home before another bidder swoops in ahead of you.

If you find a property, you will have to make a formal application for a mortgage loan, requiring even more paperwork such as updated verification of income, bank statements, proof of assets, and all that good stuff. Now you’re in the big leagues — formal underwriting by the lender will follow. 

“Underwriting” means the lender will double-check each detail and perform an appraisal on the house to make sure it’s worth the money. If the lender agrees to your loan request, it will issue a commitment letter. That’s a green light allowing progress toward the closing phase, where final documents are signed, and you become the proud parent of an 8-lb, 7-oz mortgage.

Auto Loans

An auto loan preapproval helps you negotiate with the car dealer when you’re itching to buy your next set of wheels. The preapproval takes into account your credit score and the value of the vehicle you plan to purchase. The lender will size you up and calculate how much it can gamble on you.

First, the lender will check your credit profile when you ask to be preapproved for an auto loan. The better your credit score, the better your chances of getting a loan on good terms, including a lower interest rate. 

The lender will also eyeball the facts surrounding the car you want to get. They’ll peruse the make, model, age, condition, and even how many other folks are out there looking to buy the same vehicle. All this is important in making sure that the amount of money lent corresponds to how much the car will fetch if the lender has to yank it back from you.

How Good Credit Affects Auto Loan and Mortgage Approvals
A good credit score will increase your chances of an auto loan approval.

Trade-ins and down payments can grease the deal. Even if you are trading in an old clunker, its value will decrease the loan amount you need, which may help improve your loan terms. Another way to do this is by dropping a wad of cash up front, which reduces the loan-to-value ratio and the risk to the lender. 

Both of these refinancing moves may shave your interest rate and cut your monthly payments. They may even increase how much you can borrow and make it easier for the lender to preapprove your car loan.

The lender will do some noodling to come up with a preapproval quote. The offer mostly reflects what the lender thinks you can handle before it lets you put the pedal to the metal. This preapproval quote also sets the probable interest rates and loan conditions so that you can decide whether to go for a full loan application.

Now, don’t go counting your chickens just yet. Final approval isn’t in the bag, and the interest rate can still do a little jig if the lender uncovers something unexpected from the hard inquiry.

Differences Between Preapproval and Prequalification

Now, don’t let the two words confuse you: Preapproval and prequalification may sound like two peas in a pod, but they actually are not the same things when it comes to home loans and auto loans. Both are ways to check if you are creditworthy, but how deep they dig and how serious they get can differ. 

Credit Cards

For credit cards, preapproval and prequalification are pretty much the same. Both are based on a soft credit check so that the issuer can see if you are eligible and offer you credit terms. This gives you some idea of what your credit limit may be and what kind of interest rate you’d be looking at, all without dinging your credit score.

If the issuer isn’t keen to preapprove you for an unsecured credit card, you may want to apply for a secured version. Secured credit cards require a security deposit that collateralizes the credit limit. This deposit reduces the risk for the lender, which is necessary when trying to obtain a credit card with either no credit history or really bad credit habits such as running up bills and forgetting to pay.

Unsecured Credit CardsSecured Credit Cards
No deposit or collateral is required to open an accountA refundable deposit is required to open an account
High risk to the issuerLow risk to the issuer
Low-fee cards require at least fair creditLow-fee cards available to most credit types
Credit limit is based on credit profile and incomeCredit limit is based on the size of the deposit

Using a secured credit card the right way — that is, paying on time and keeping low account balances — can really help boost a poor credit score. This increases the likelihood of being approved for an unsecured credit card and other credit products over time. In addition, many secured credit cards are not bare bones; they may have many of the same features as unsecured credit cards, such as rewards programs and credit-building tools, which can be quite useful in clawing your way up to good credit.

Mortgages

For mortgage loans, prequalification basically involves telling the lender about your income, debts, and assets. In turn, the lender will provide you with a rough idea of the loan amount you may be able to get. It’s the fastest way to get an approximate loan amount without the lender really digging into your financial closet. 

Since it’s based on what you tell the lender, prequalification is fast and less formal. While this can be useful in rough budgeting and for getting a feel for how big a loan you can swing, prequalification does not carry the same weight as preapproval. It is by no means a guarantee that you’ll get the loan amount you want.

Mortgages: Prequalification vs. Preapproval infographic
Preapproval is more official than prequalification.

Preapproval is a different kettle of fish. The mortgage lender rolls up its sleeves and pulls out a hard credit check to review your credit history, income, and assets. You’ll have to provide detailed financial documents such as pay stubs, tax returns, and bank statements, among others. You’ll also give the lender some notion of your estimated down payment. 

After all that financial poking and prodding, the lender can tell you a preapproved mortgage amount that is a whole lot more realistic and reliable. Preapproval gives a clear idea of how much you can borrow. Also, it puts you on firmer ground in the eyes of sellers in the real estate market. Most sellers and real estate agents like working with preapproved buyers since it shows that financing from a lender is likely. Your offer is more attractive and competitive because you’re the buyer with the bucks.

Auto Loans

When it comes to auto loans, prequalification gives you a lay of the land regarding loan terms the lender may offer you. It’s quick, easy, and does not involve digging too deep. 

Preapproval, on the other hand, means that the lender has combed through your financial documents and credit history. It may then offer you a loan amount and terms. This adds weight to your credibility with private sellers and car dealerships.

Car lenders can often be banks, credit unions, or car dealers. There are some key differences in how the loan process plays out, depending on who is holding the purse strings.

Car Loans From a Bank or Credit Union

Prequalification usually means a preliminary review in which you provide lenders with your basic financial information, such as income, debts, and credit score.

Bank or credit icon

It’s like sticking your toe in the water to get an estimate of what you may qualify for from the bank or credit union without jumping feet-first into a hard credit inquiry.

The preapproval process is a bit more substantial. It requires detailed financial documents, proof of income, tax returns, credit reports, and so forth.

The lender will look at everything and come back with a specific loan amount, interest rate, and terms for you. This helps beef up your bargaining power at the negotiating table.

Car Loans From Dealerships

Vehicle prequalification is most often a quick review. The dealer checks your ability to pay for a car loan using basic credit information and income. It is relatively informal but does give you some idea about what you may be able to afford. 

Car dealership icon

Preapproval at a car lot usually centers on the vehicle you want to purchase. In-house financing requires you to provide the dealer with all your detailed financial information and credit history.

Many times, the dealer can give you immediate loan terms for the car you plan to buy. The dealer may be able to sweeten the deal through its partnerships with banks and other financial institutions. 

While prequalification and preapproval both give you an idea of how much you can borrow, it would be fair to say that a bank or credit union’s preapproval will generally be more complete, formal, and reliable. Don’t discount the dealers as loan sources — they can act fast and get you preapproved right on the lot, which can be mighty convenient when you are set to drive off into the sunset.

Common Misconceptions About Preapproval

There are a lot of tall tales about preapproval that might confuse you if you buy into them. That may cause you to make some bad financial decisions. You may think that getting preapproved means you’re a shoo-in for the loan, or perhaps you’re worried that preapprovals will ding your credit score and prevent you from taking advantage of good opportunities.

Because of this, it’s essential to crack some of the worst myths wide open. Having the correct information ensures that you see preapprovals for what they truly are and how to use them without upsetting your financial apple cart.

Preapproval Guarantees Credit Card or Loan Approval

Preapproval does not guarantee final approval of a loan or credit card. You will still need to go through the formal application Kabuki dance afterward. During the process, loan providers will crunch the numbers to verify your financial condition and creditworthiness. 

Sometimes, if a lender finds something that does not check out, they may alter or even back out of the whole deal. 

Even after initial preapproval, a bunch of factors could mess up the works. Say, for example, a lender sees changes in your financial condition — such as recent job loss, extreme increases in debt, or some discrepancy noted in your application. These influence the lender’s final call, even if you were preapproved. So don’t assume you’ve got everything lined up until the lender gives you the nod.

Preapproval Negatively Impacts Credit Scores

There’s another whopper floating around claiming that preapproval always hurts your credit score. However, the simple truth is that many credit card and loan preapprovals require only a soft credit check and do not affect your credit score at all.

This kind of credit check is just for preview purposes and will not be visible in your credit report to anyone but you. So don’t work up a sweat — you can freely look into your preapproval options without messing up your credit score. 

However, mortgage loan preapprovals are the odd ducks that require a hard credit check. That’s because when you’re out shopping for a home, the lender wants to make sure you’re really ready to buy.

Preapproval Helps You Make a Better Borrowing Plan

Preapproval is like a map to guide you as you enter uncharted territory. It helps you estimate how much you can borrow so you can plan accordingly. Knowing that you may receive a specified loan amount and interest rate gives you a better picture of your finances and keeps you from stretching your budget too far.

Preapproval can ease your financial stress and boost your credibility as a borrower, thereby putting you in a better negotiating position. For credit cards, it lets you quickly see whether it’s worth applying for a particular card, all without affecting your credit score.

With a loan preapproved in your pocket, home sellers and car dealers perk up their ears because it proves you are a serious buyer. No one is going to stick you in the closet, baby, when you have a lender’s backing.