Pre-Approval: Definition, Meaning, How It Works, and Types

What Is a Pre-Approval?

A pre-approval is a preliminary evaluation of a potential borrower by a lender to determine whether they are likely to be approved for a loan or credit card. Though a pre-approval isn't a guarantee that your loan application will be approved, it's the closest you can get without actually applying.

You can be pre-approved for nearly any type of loan, including a mortgage, auto loan, personal loan, or credit card. However, the process for each type of loan varies significantly, as does the impact on your credit.

How Does Pre-Approval Qualification Work?

During the pre-approval process, a lender does a surface-level assessment of a borrower's financial situation to determine whether they're a good candidate for a loan or credit card. Depending on the type of loan, pre-approval could result in either a soft inquiry or a hard inquiry to your credit report.

For example, you may be pre-approved for a credit card—possibly without even applying—without it impacting your credit. However, pre-approval for a mortgage generally requires a hard inquiry into your credit, which will likely impact your credit score.

Pre-approval generally includes a few specific features, including an estimated interest rate offer and a maximum principal amount.

Once pre-approved for a loan or credit card, you'll complete the official credit application. At that time, the lender will make a hard inquiry of your credit report (if they haven't before) and assess your employment history, debt-to-income ratio, and other aspects of your finances to determine whether you qualify.

A pre-approval doesn't guarantee you'll ultimately be approved for the loan, partly because the process doesn't require a deep dive into your finances. Information not found during the pre-approval process could arise during the approval process and disqualify you from getting a loan. Additionally, your pre-approval offer could include a different maximum loan amount or interest rate than your final approval.

Pre-approved mortgages will often have the greatest variation between a pre-approved offer and a final offer since mortgage loans are obtained with secured capital. Secured capital increases the number of variables that must be considered in the underwriting process.

Underwriting for a mortgage loan typically requires a borrower’s credit score and two qualifying ratios: debt-to-income and a housing expense ratio. In a mortgage loan, the secured capital may also need a current appraisal, which usually affects the total principal offered.

Types of Pre-Approval Offers

There are many different types of pre-approval offers you can receive. First, many lenders send high volumes of pre-approval qualifications for credit cards, auto insurance, or private loans, for example, each year through both direct mail and electronic mail.

These pre-approval offers are marketing material for credit card companies and other lenders. They are usually based on a soft inquiry of your credit profile, meaning you don't have to go through a hard credit check. In fact, you may not have even applied for or expressed interest in being pre-approved. You may notice these pre-approval offers increase as your credit score improves.

These pre-approval offers usually come with a special code and an expiration date. Using the special code provided by the lender can help to differentiate a borrower’s credit application and give the borrower some higher priority within the lending process.

There are other types of pre-approval offers that you must seek out rather than getting a marketing letter in the mail. For example, if you are in the market for an auto loan or a personal loan, you could get pre-approved with several lenders to find the best fit. Depending on the lender, this process may or may not require a hard inquiry.

How Mortgage Pre-Approval Works

Mortgage pre-approval is a more in-depth process than pre-approval for other types of loans. First, mortgage pre-approval usually requires a hard inquiry in your credit report, meaning it may temporarily impact your credit score.

In addition to going to a hard inquiry, pre-approval will also require a basic review of your overall financial situation. You must provide information about your employment, income, assets, liabilities, and more to help the lender determine whether you're a good candidate for a loan.

Once pre-approved, you'll receive a pre-approval letter that lays out the amount you've been pre-approved for, an estimated interest rate you may qualify for, and the expiration date of the pre-approval. If you're still shopping for a home when the pre-approval expires, you may need to get pre-approved again.

Qualifications for Pre-Approval Offers

The most important factor in getting pre-approved for any loan is your credit score. Each lender will have a minimum credit score you'll need to qualify for the loan. For example, the minimum credit score to qualify for a conventional mortgage loan is 620.

In addition to your credit score, lenders will look at other aspects of your credit report. If you have delinquent accounts or frequent late or missed payments, you may be unlikely to be pre-approved.

Other factors lenders consider when pre-approving you for a loan are your employment status, income, and debt-to-income ratio. While each lender and loan type may have its own requirements, a good rule of thumb is to have a debt-to-income ratio of 36% or less.

The Bottom Line

Pre-approval is an important first step in qualifying for any type of loan or credit, including mortgages, auto loans, personal loans, credit cards, and more. Getting pre-approved can help you learn whether you'll be approved for a loan, as well as the maximum loan and interest rate you may be approved for. Of course, a pre-approval doesn't guarantee anything—it doesn't guarantee you'll be approved, nor does it guarantee the loan amount or interest rate you've been pre-approved for.

Pre-approval is most helpful when you're shopping around for a lender. You can use this step in the process to identify the lender that can offer you the best loan terms or interest rate, or provide the size of loan you need.