Prequalification is a term every consumer should know. Bankrate explains it.

What is prequalification?

Prequalification is an initial evaluation of an applicant’s ability to qualify for a loan. Prequalification is used in the mortgage process to give lenders an idea of how much a person can borrow and what kind of loan terms she might qualify for.

Deeper definition

Prequalification is the first step in the home-loan process and can be done for other types of debt, too. A consumer supplies information to the lender or a third party about her income, expenses and loan needs, and based on this information, the borrower’s preliminary credit score and the available loan options, the lender makes an offer. One of the most important factors in getting prequalified is the borrower’s debt-to-income ratio.

Prequalification, however, it is not the promise of a loan. It is simply an estimate of how much a potential borrower can afford, and can help her make a decision about what lender to get her loan from. Prequalified borrowers don’t have to commit to anything, and, unlike the actual application process, their credit won’t be affected by a hard inquiry.

To prequalify for a loan is not the same as preapproval. The preapproval stage comes second, after the lender has gathered more information about the borrower. This includes verification of the information she provided to get prequalified, including her income, credit score, expenses and other details that would affect the loan decision.

Most consumers will obtain prequalification before applying for a loan. The process is often as simple as filling out a basic application, which can even be done online. If prequalification is granted, the lender will begin the process of preapproval.

Prequalification is frequently a part of the mortgage application process, but it’s also used when applying for other types of loans, as well as revolving debt like credit cards. Credit prequalification works a little differently in that financial institutions will frequently prequalify customers without their knowledge, based on information the financial institution received from a credit bureau. This helps the bank cast a wide net for people to offer its credit cards and other financial products to.

Hoping to get prequalified? Use Bankrate’s mortgage calculators to see how much you can afford to borrow.

Prequalification example

Katy hopes to buy a house. Before she can begin to shop for one, she needs to determine how much house she can afford to buy. She applies for a mortgage online. The lender requests basic information about her debts and income. A credit score is pulled. The lender then says Katy is prequalified for a loan of $250,000. She must then submit documentation and undergo a more rigorous approval process.

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