What is preapproval?
Preapproval is the state of becoming eligible for debt from a financial institution, whether that means a loan or a revolving line of credit. When a borrower is preapproved, she has already submitted her financial information to a lender and the lender has already calculated what the borrower can afford based on that information. Preapproval is often the last step before actual approval and can make it easier for a buyer to negotiate with a seller.
There are a couple of steps in the loan process before the lender finally issues the loan. The first is called prequalification, in which the borrower submits preliminary details about her financial situation, and the lender creates a rough sketch about what the borrower can afford and prequalifies her for a certain amount.
The next step is preapproval. Being preapproved means the lender has verified the preliminary information sent in the prequalification step. The borrower often has to submit such information as W-2 forms and bank statements that prove how much she can afford to borrow. The preapproval process includes a hard inquiry into the borrower’s credit report, which can reduce her credit score by a few points.
Preapproval often comes in the form of a letter that a home buyer can present to her real estate agent to show that the bank is willing the front the money for the home. However, preapproval is not the same as being approved for a loan, and neither party has a commitment to the loan until final approval. To move on from preapproval into final approval, buyers have to demonstrate that they can afford closing costs, including the down payment.
Preapproval is also part of the process in obtaining a revolving line of credit, such as a credit card. Many financial institutions run a soft inquiry, which doesn’t have a credit score penalty, on a large batch of customer credit reports in order to determine who’s eligible for certain financial products. Preapproved customers have already had a close look at their credit by the bank, but they still need to actually apply. The credit card company can still reject the application despite preapproval, although that may be unlikely.
Jack receives a flyer in the mail saying that he is preapproved for a credit line of up to $1,000. This indicates the lender has screened Jack through a soft inquiry and determined that he may be eligible for the line of credit. If Jack wants the credit card, he will need to formally apply with the lender. At that time, the lender will make a lending decision based on a more careful look at Jack’s credit history. Jack does not have to apply for the credit card and, if he does not, it will not impact his credit score.