How to Prequalify for a Personal Loan

What does it mean to prequalify for a personal loan?

When you apply for a personal loan, the lender does a credit check to determine if you’re likely to pay back the money you borrow.

This puts a “hard inquiry” on your credit report, which may cause your credit score to drop a few points. If you don’t want an extra inquiry on your record, you can get prequalified before you submit an application.

prequalification helps you understand how much a bank, credit union or finance company is willing to lend you based on your income, credit history and other factors. Most lenders do a soft check instead of a hard check, leaving your credit score intact while you explore your loan options.

Prequalification vs. preapproval

Loan prequalification is a little different from loan preapproval. When you go through the prequalification process, you give the lender a big-picture view of your finances. Generally, you list your income, debts and assets.

Preapproval is a little more rigorous. Rather than just telling the lender how much you earn or how much debt you have, you must provide proof of income, employment and assets. During this process, the lender checks your credit.

Neither process is a guarantee of loan approval. You still have to complete an application and go through the other steps in the application process.

Why should you get prequalified before applying for a loan?

Here are the top reasons to get prequalified before you apply for a personal loan:

• Efficiency: If you prequalify for a personal loan, it may take the bank less time to approve your application.
• Budgeting: When you prequalify, the bank tells you how much you can afford to loan. This makes it easier to estimate your monthly payment and determine if it’s likely to fit into your budget.
• Loan comparison: If you prequalify with multiple lenders, it’s easier to compare your loan options and determine which one is the best fit for your needs.
• Avoiding too many inquiries: Prequalification helps determine your chances of qualifying for a personal loan. If a bank isn’t willing to lend you money, you can avoid completing an application and having a hard inquiry show up on your credit report.

How to get prequalified for a loan

When you’re ready to get prequalified, follow the steps below:

Consider your financial situation and needs

Before you shop for a lender, make sure you know your credit score and debt-to-income (DTI) ratio. Many lenders use FICO scores, but your lender may request your VantageScore. Both models use your payment history, total amount of debt and other factors to determine your credit scores.

The United States has three major credit bureaus: Equifax, Experian and TransUnion. Due to differences in each scoring model, it’s possible to have a credit score that’s much higher at one bureau than it is at another bureau. For example, you can have a 770 FICO score at TransUnion while scoring just 715 at Experian.

Your DTI ratio compares how much debt you have to how much gross income you have. To calculate your DTI, divide your monthly debt payments by your gross monthly income. For example, if you have $4,000 in gross monthly income and $560 in minimum monthly debt payments, you have a DTI of 14%.

This ratio helps lenders understand how much you can afford to pay each month. The lower your DTI, the more wiggle room you have in your budget. Although it’s best to have a DTI below 20%, many lenders approve applicants with DTIs as high as 36%.

Research and compare lenders

Some lenders offer much better loan terms than others. Before prequalifying, shop around to determine which lenders offer the best rates and lowest origination fees.

Fill out the prequalification form

When you’re ready to prequalify for a personal loan, you’ll have to fill out a form with your name, contact information, date of birth and Social Security number. The lender will also ask for your income, desired loan amount and desired loan term. Your loan terms have a big impact on your interest rate, so think carefully before you submit the form.

Undergo a soft credit check

Next, the bank conducts a soft check of your credit. A soft check is a review of your credit history that has no impact on your credit score. It’s different from a hard credit check, which does affect your score. This helps your loan officer determine if you’ll likely meet the lender’s requirements for a personal loan.

Evaluate your offers

Since a soft check has no impact on your credit, it’s wise to prequalify with several lenders and then compare the loan offers you receive.

Once you have these offers in hand, compare them by taking the following steps:

• Check interest rates and fees. The higher your interest rate, the more it costs you to borrow money. Comparing loan offers allows you to identify the one with the best interest rate, reducing the amount of money you must repay.
• Consider the loan terms. Lenders have different rates, repayment terms and origination fees. Some lenders even charge a prepayment penalty, which is an extra fee charged if you want to pay off your personal loan early. Compare your offers to determine which lender offers the best combination of terms for your financial situation. For example, one lender may be willing to give you a larger loan amount at a lower rate than another lender.
• Review the loan time frame. Some lenders offer lightning-quick approvals, while others take more time to review the information you provide. If you need the funds from a personal loan right away, make sure you compare each offer based on how long it takes to fund the loan.
• Check for any perks. You may qualify for certain perks if you get a personal loan from one lender over another. For example, some lenders give you a slight discount on your interest rate if you agree to set up auto-pay. These perks can help you save money.

After getting prequalified

To get approved after prequalification, a borrower must follow these steps:

1. Apply for a personal loan. You may have to provide additional financial information to help the lender determine if you qualify. For example, a bank may ask a borrower for pay stubs and W-2 forms to verify their income.
2. Undergo a hard credit check. Once you complete the application, the lender does a credit check to make sure that you meet the loan requirements. There’s nothing you can do here except wait for the lender to receive your credit history and review it.
3. Give the lender additional information as requested. For example, you may have to show your ID to prove your identity.

If you’re approved, check the loan agreement carefully before signing it. Make sure it has the right loan amount, interest rate, origination fee and repayment term. Once you sign, the lender will fund your loan by giving you a check or depositing the funds into your bank account.

If you’re not approved

If the lender denies your application, you’ll receive a letter telling you the reason for the denial.

This is known as an adverse action letter. The notice should also include your current credit score and the name of the agency that provided your credit report. Review this letter carefully to understand why you didn’t qualify for the loan. Once you know the reason for the denial, you can work on improving your credit score or developing it if you have no credit history.

How to increase your odds of approval

Here’s how to increase your chances of approval as a borrower:

• Pay down your debt: If you have a high DTI, hold off on applying for another loan. Use the time to pay off as much debt as you can.
• Apply with a co-signer: You may be more likely to qualify for a personal loan if you have a cosigner with excellent credit.
• Shorten the loan term: Shorter terms come with lower rates, so you may qualify for a short-term loan even if you don’t qualify for one with a longer repayment period.
• Take out a secured loan: When you take out a secured loan, you use a valuable asset as collateral, giving the lender the right to sell the asset if you default on the loan. This reduces the risk to the lender, which may help you qualify.
• Limit new inquiries: As noted earlier, hard inquiries have a negative impact on your credit score. Too many inquiries also make lenders wonder if you’re having financial trouble, so they can prevent you from qualifying for a loan.