What exactly is a pre-approved loan?
A pre-approved loan is not a loan that is already approved, contrary to what a lot of us tend to believe. On the other hand, as the name suggests, it is something that is just prior to the approval stage. This means it is a loan that is not yet approved by the bank.
Broadly, there are two kinds of pre-approved loans. First, there are loans offered by banks at random based on a customer database procured and after running some basic quality checks. These are just like unapproved loans and you will be required to go through the complete documentation and quality checks.
Second, there are pre loans that are based on an existing relationship with a bank. For example, if you have taken a home loan from an ICICI Bank or a consumer loan from Bajaj Finance, they may offer you a pre-approved home improvement loan or a pre-approved spending card. Here, the loan approval can be completed with minimal documentation. When we talk of pre-approved loans, we normally refer to the latter category.
There are certainly some merits in pre-approved loans
If you get an offer for a pre-approved loan from a bank or NBFC with whom you have an existing relationship, there are some benefits you may get.
- Normally, such pre-approved loans are available at discounted interest rates. For example, based on an existing relationship the bank may offer you a personal loan at 1% lower rate of interest than prevalent rates. This is a normal benefit that most pre-approved loans provide.
- Second, you are aware that all loans have charges like the cost of insurance, the processing fee, legal charges. Most lenders offer pre-approved loans either by waiving the legal charges or by halving your processing fees. This is another advantage.
- The third advantage you can get in a pre-approved loan is that the processing time is normally much quicker. Since most of the ground work is already done by the bank, they will be willing to give you the pre-approved loan with minimal documentation. This will reduce your disbursal time.
What should you watch out for when accepting a pre-approved loan?
- Take a pre-approved loan only if you actually need it. Quite often, home loans are followed up with a pre-approved loan for home improvement. This can be quite tempting as you may have been planning the marble finish or shifting to Italian tiles or that exquisite modular kitchen. Exercise caution and only take the loan if you absolutely need it.
- As stated earlier, every pre-approved loan has to go through necessary credit checks. For example, the pre-approved loan if added to your existing loans may jeopardize your credit score. In that case, the loan could be rejected and every loan rejection is a negative mark on your credit score. Talk to your banker about the likely impact on your credit score before accepting the pre-approved loan offer.
- Check the EMI impact on your monthly budget. Credit scorers give a lot of importance to how much of your income goes towards EMI servicing. For example, if your EMI outlay goes up from 40% to 50% of income as a result of the loan, your credit score could be negatively impacted. Often, people only realize this after the loan has been taken.
- Read the fine print of the pre-approved loan. Most pre-approved loan approvals have some conditions. For example, the approval may be subject to a detailed review of your financial standing. The lender could also insist on mortgage of an asset for easier processing, which has an opportunity cost.
- Do a comparative study in the marketplace. For example, you may be able to get a loan at a rate lower than the pre-approved rate offered. Take a bit of trouble to shop around in the market. In fact, as a smart borrower, you can also use your pre-approval letter to press other financers for a better rate of interest.