Do Pre-Approvals Hurt Your Credit

Do Pre-Approvals Hurt Your Credit?

Mortgage pre-approval can help potential homeowners understand what types of mortgages they qualify for. This information could also help someone understand which houses are within their budget. However, mortgage pre-approvals may also hurt one’s credit. Luckily, there are some ways to limit this impact. 

What Is Mortgage Pre-Approval?

A mortgage pre-approval is a step you may want to take when you begin to shop for a new home and mortgage for that new home. A mortgage pre-approval requires an in-depth review of your finances by a lending institution. These institutions can be loan officers, banks, or other lenders. The review process considers many aspects of your current and past financial life. For instance, you’ll provide information about your current income, credit history, debt, savings, investments, and other financial data. Once a lending institution receives this information, it will obtain a credit report and calculate the loan products and loan amounts you may qualify for.

When the lenders give you loan options, you’ll be able to compare interest rates, fees, and term differences between loan options. However, mortgage pre-approval does not guarantee you’ll qualify for the loan if you officially apply for it at a later date. The process simply provides insight into what loans you could be eligible for.

Still, a benefit to a mortgage pre-approval is that the lender will give you an official letter detailing the current loans and loan amounts for which you may qualify. This information can be used while shopping around for a home. A potential seller could favor someone they know will likely be able to purchase their property and often request a pre-approval letter from potential buyers. At the very least, it may give someone an advantage over other buyers without this information.

Should You Get a Pre-Approval?

Mortgage pre-approval may be suitable for some but not for others. Consider the following benefits to pre-approval:

• Pre-approval will give a buyer a realistic idea of how much they can borrow. Some people may assume they can qualify for a mortgage loan, but in reality, they may not meet the lender’s approval requirements. In contrast, others may be surprised by their loan options. Pre-approval can bring clarity to one’s current mortgage potential when shopping for a new home.
• Pre-approval gives a prospective home buyer negotiating power. For instance, if you know you’ve been pre-approved for a $500,000 mortgage, and a home is listed for $400,000, you can confidently enter a bidding war with another buyer within your limits. Just be aware that the home will need to appraise for the amount you pay in a bidding war.
• Pre-approval may expose some credit issues a buyer is unaware of. If you aren’t approved for the loan amount you’d hoped for, it could be an opportunity to understand your credit profile better and what you may need to do to improve it. 

However, consider some negatives to the pre-approval process:

• In the pre-approval process, lenders review your income and debt obligations and calculate your debt to income. This often doesn’t take into consideration things like home utilities, groceries, the cost of gasoline and vehicle maintenance, or even child care. It is possible to get approved for a loan that a buyer cannot realistically manage. You don’t have to use that much credit if you’re approved for a large loan amount; it’s simply the largest loan you qualify for. When shopping for mortgages, keep a realistic view of your current financial situation and what forms of debt you’re able to manage.
• Your credit score will likely decrease by getting pre-approved. Credit scores are sensitive to credit inquiries. There are two types of credit inquiries: soft inquiries and hard inquiries. A mortgage pre-approval is a hard credit inquiry. This inquiry type is more damaging than a soft credit inquiry. This dynamic is something to be cognizant of before getting pre-approved with multiple lenders.

How Mortgage Pre-Approval Affects Your Credit

Lenders need to complete a thorough credit investigation to determine the loan options for which one may qualify. To accomplish this task, lenders examine your credit report. This process involves a hard inquiry into one’s credit. As mentioned before, a hard inquiry is different from a soft inquiry. Continue reading to better understand the distinction between these two types of credit inquiries.

Hard Inquiry 

A hard inquiry occurs when a lending institution wants to examine your credit for the purpose of lending you money. Hard inquiries occur when someone applies for a credit card, a car loan, a mortgage, or other loans. It’s a definite sign that someone is looking to take on a new form of debt.

Credit reports record hard inquiries. Hard inquiries lower one’s credit score because they indicate that someone may be taking on new debt and could potentially become financially overextended. Hard inquiries most negatively affect your credit score when there are many of them not grouped together. For instance, if someone has a hard inquiry every month over the course of a year, their credit score will dip. Furthermore, lenders may deny an applicant if they see the applicant has recently tried to apply for too many lines of credit.

Mortgage pre-approvals are considered hard inquiries on one’s credit report. Consider this information when entering the pre-approval process.

Soft Inquiry

Soft inquiries occur when a lender is looking to pre-approve someone for a credit card or a lender conducting periodic reviews of your existing credit accounts. A credit card company can run a soft credit check to give a potential customer an idea of what credit cards they currently qualify for. Furthermore, a soft inquiry usually occurs when someone orders a personal credit report from one of the major credit bureaus. Soft inquiries do not impact credit scores. 

How Do Traditional Pre-Approvals Impact Your Credit

According to FICO, a single credit inquiry can decrease your credit score by five points or less. If you have a strong credit history and no other credit issues, the credit score impact will lessen.  However, keep in mind that multiple inquiries can sink your credit score even more. If you have a limited credit history, multiple inquiries may damage your credit score more than those with longer credit histories.

Hard inquiries have a temporary impact on a credit score. If the decrease is due only to hard inquiries, scores will bounce back up again and usually recover within a few months, assuming everything else on the credit history remains positive. 

How Long Does a Pre-Approval Impact Your Credit

Any form of hard credit inquiry can stay on your credit report for up to two years. To limit the negative effect of these inquiries, try grouping applications together (14-30 days). 

How to Get Your Credit Ready for a Mortgage

Reviewing your credit report before entering the mortgage pre-approval process is helpful. Credit reports are easy to access through any one of the major credit bureaus. Experian, TransUnion, and Equifax all offer free online credit reports. If you don’t know your current credit score, order a credit report from one of these companies.

Once you’ve checked your credit score, consider utilizing some of the following tips to increase your score. Having a better credit score will help increase your odds of getting pre-approved for better loan options.

• Research the main items that determine one’s credit score. Credit scores can be complicated, but credit reporting agencies have consistent ways to calculate a score. Understanding the weightiest factors in a credit score calculation can help you strategize ways to increase your credit score.
• Correct inaccuracies on your credit report. There may be fraudulent activity on your credit profile. Correcting this information will help increase your score.
• Don’t apply for new lines of credit. Instead, take care of the current credit you have. Make timely monthly payments, try to always pay the minimum payment required, and pay back any debt you can.

If you follow these strategies, you may see an increase in your credit score. However, credit improvement often takes time. Stay consistent in your payments and prioritize wise financial stewardship for the long run, and you’ll likely see the changes you want.

Summary

There are evident benefits to getting pre-approved. You show potential buyers you’re serious, and you get a realistic understanding of loan options for which you may qualify. However, pre-approval may lower your credit score. Try grouping pre-approval applications in the same period of time when you are shopping for a home loan to limit this negative effect, if possible. 

If you’re not eligible for the mortgage loan amount you want, consider improving your credit and credit score. Lenders will likely extend better credit opportunities to those who’ve proven they’re creditworthy.