Prequalification vs. pre-approval for HELOCs and home equity loans

If you've ever applied for a home equity loan or home equity line of credit (HELOC), you've probably heard the terms prequalification and pre-approval. Don't feel bad if you don’t know the difference between the two. They sound so much alike it's enough to confuse anyone. Here, we'll clear up the confusion, making it much easier to nod confidently the next time a loan officer tells you that you've been prequalified or pre-approved. 

What is prequalification for a HELOC or home equity loan?

At the beginning of the home equity loan process, you’ll be asked for basic information, like your name and Social Security number. The number of questions you’re asked varies by lender. In short, the lender wants to know more about you and take a peek at your past experiences with credit.

Here’s why that’s a good thing: If a lender checks you out and doubts that you will qualify for a loan, they won't waste your time. Another good thing about prequalification is that many lenders run a soft credit check rather than a hard one during the prequalification process. While a hard credit check can cause your credit rating to dip, a soft check does not impact your credit.

Once you receive prequalification, the lender will tell you more about the interest rate you might qualify for and give you an estimate of your borrowing capacity.  

When a lender tells you that you’re prequalified, they’re saying that you might qualify for a loan. It’s like being asked out on a second date. They would like to see more based on what they've already seen.

What is pre-approval for a HELOC or home equity loan?

During HELOC or home equity loan pre-approval, the lender dives into your application more deeply, verifying your credit standing, employment, income, debt, and savings. If prequalification is like being asked on a second date, pre-approval is like a marriage proposal. In short, the lender wants to commit to you. There are three situations that could cause the lender to back out after offering pre-approval:

• Your credit standing takes a hit. If you make a late payment following pre-approval, it could  be reported to at least one of the three major credit bureaus—TransUnion, Equifax, or Experian.  Lenders typically review your credit report twice. The first look is before offering pre-approval, and the second time is after the hard credit pull has occurred and the loan application submitted. If anything changes within that time frame, the lender will reevaluate your ability to repay the loan. 

• You make a large purchase after receiving pre-approval. Your pre-approval was based on the debt you carried when you applied for the loan. Taking on new debt after pre-approval may push your debt-to-income ratio too high for the lender to remain confident that you can make the monthly payments. 

• There are changes to your income or employment. An income or employment status change will cause the lender to reassess your loan. However, that doesn't mean that the lender will definitely back out. Let's say you're transitioning from one job to another, but they're in the same field and your income remains stable. That's less risky than switching job fields entirely or accepting a lower-paying position. 

Note: The lender typically conducts a hard credit pull to offer pre-approval. Hard checks usually cause a slight, temporary dip of your credit score. 

Key differences between prequalification and pre-approval for HELOCs and home equity loans

The critical difference between prequalification and pre-approval is this: 

• Prequalification typically means, "We think you'll be able to qualify for this HELOC or home equity loan."

• Pre-approval means, "You have everything we're looking for in a borrower. And as long as things remain the same, you qualify for this loan." 

While prequalification and pre-approval are quite different, they're both tied to your credit report and can be revoked if your credit report, job or income significantly changes. 

Pros and cons of prequalification and pre-approval 

Prequalification pros

• Most lenders conduct a soft credit check without impacting your credit score.

• Once prequalified, you're given loan details, including the interest rate, how much you might qualify to borrow, and how much you could pay in loan fees.

Prequalification cons

• It's not a final, definite "yes." You'll still have to wait for pre-approval. 

• You're only offered an estimate of how much you can borrow. 

Pre-approval pros

• You're being told that you do qualify. 

• As long as everything stays the same, you typically have no more hoops to jump through or qualifying information to provide.

Pre-approval cons

• If your employment, income, or credit report changes before you close, the lender can choose to decline your loan approval . 

• Your credit report will likely take a slight, temporary dip when the lender conducts a hard credit check. 

When should you get prequalified or pre-approved?

One of the most important things you can do before settling on a home equity or HELOC lender is to shop around. Once you're confident a lender has what you're looking for, it's time to get prequalified.

Once you're prequalified, you'll learn the details of the loan, like the interest rate you might qualify for. If you're happy with the rate, loan fees, and loan term, it's time to provide the lender with the documents typically needed check forpre-approval. Required documents are likely to include:

• Permission to run a hard credit check

• Pay stubs

• Tax returns

• Homeowners insurance policy

• Recent mortgage statements

• Real estate appraisal (how lenders handle this varies)

• Bank statements

Prequalification and pre-approval for personal loans

Prequalifying for a debt consolidation personal loan is similar to prequalifying for a HELOC, minus the need to provide information about your home. In short, you'll be asked to supply basic information, like your name and annual earnings. If the information you provide leads the lender to believe you have a good chance of loan approval, it will let you know that you're prequalified. 

To be pre-approved, the lender will take a deeper dive, asking you to provide documentation. To speed the process, you may want to have a current photo ID, pay stubs, tax returns, and bank statements ready to share. A lender wants to know that you can easily make the monthly personal loan payments and that you're not getting in over your head. 

What's next

If you're serious about a home equity loan or HELOC, your first task is to review your household budget. For a moment, forget about what a lender will think. Are you 100% confident you can make the monthly payments with no problem?  With a home equity loan or HELOC, your home acts as collateral. If you fail to make payments, the lender can repossess your property, sell it, and recoup its losses. 

Once you're confident that you can make the payments (and have a plan in place in case of job loss or serious illness), it's time to shop for the lender that best meets your needs.