Everything You Need to Know About Those Pesky Credit Inquiries
You’re wondering how to improve your credit scores, you’ll have to first understand what determines those three-digit numbers. Most credit scoring models factor in five major categories when looking at the information your credit reports: payment history, credit utilization, mix of accounts, age of your credit and credit inquiries. Credit inquiries, which account for 10% of most credit scores, are generated whenever you apply for new loans, go to take out certain service contracts, pull your own credit reports and, even, apply for a job. Too many “hard inquiries” (more on what that means later) will hurt your credit scores, since lenders view that as an early sign of risk. It can look like you’re overextending yourself and taking on more financing than you’ll ultimately be able to afford. Let’s break down credit inquiries further so you understand how they impact your credit scores.
What’s in a Credit Score?
Our look at credit inquiries is the last of our five-part series investigating credit scores and how your credit-related actions most influence them. Each edition of the series explored a new category chosen because of the amount of credit score points that each could cost you if not managed properly. (You can view your credit scores on Credit.ly) So far we’ve explored the following four of them:
- Your Payment History: Worth 35% of the points in your credit score. The most important category.
- Your Amount Of Debt: Worth 30% of the points in your credit score. It’s surprising to some that your debt is almost as important as payment history.
- How Long You Have Had Credit: Worth 15% of the points in your credit score. The older your credit history, the better your score.
- The Type of Accounts In Your Credit Reports: Worth 10% of the points in your credit score. A healthy mix means more points.
Collectively, these four categories account for 90% of the points in your credit scores. Without solid performance in each of these areas, it would be impossible to earn a score high enough to qualify for credit at the best interest rates and terms.
Your History of Searching for Credit or Credit Inquiries
The last of the five categories is Your History of Searching for Credit or Credit Inquiries. This category is worth the final 10% of the points in your credit score. So why is this one important and why did it get saved for last? The reason is that this category includes measurements taken from perhaps the most misunderstood part of your credit reports: those credit inquiries.
“Inquiries” is the fancy name for the section of your credit report that keeps record of who pulled your credit report, when and for what purpose. Any time anyone pulls your credit report, federal law requires that each of the three credit reporting agencies keep a record of that activity for up to 24 months. This record is commonly referred to in the lending industry as an “inquiry for credit.” Every time you apply for a loan, prequalify for a mortgage, fill out a credit card application or ask for a copy of your own report an inquiry is posted to your record. It’ll look something like this:
Recent Credit Inquiries
|GEORGIA NATURAL Gas
|LAND AM CR S
|LAND AM CR S
There are many different types of inquires because people will look at your credit report for many different reasons. They’re mainly put into two categories: hard inquiries and soft inquiries.
The term “hard inquiry” is industry jargon used by creditors. It means that you’ve applied for credit from some sort of lender. A hard inquiry will show up on your credit report when you do any of the following:
- Apply for a car loan
- Apply for a student loan
- Prequalify or apply for a mortgage or other home-related loans such as a home equity loan
- Fill out and return any of the many “pre-approved” offers of credit that you get in the mail
- Take advantage of “instant credit” offers when you are at the shopping malls
- Apply for a store credit card from an electronics retailer
- Apply for credit from any lender using the internet
The common theme among all of these examples is, quite frankly, you. You have made the conscious decision to apply for something from someone who has offered you the benefit of credit. This act is captured, recorded and displayed on your credit reports as a hard inquiry. These inquiries will show up on your credit reports for two years. Any company who pulls your credit reports will be able to see the entire list of hard inquiries. Credit scoring models will also see them. They are fair game.
Again, this is an industry term used by creditors. Soft inquiries are a record of when someone pulls your credit reports for a reason other than making a decision on your credit applications. Soft inquiries will show up when any of the following occurs:
- A lender has purchased your name from the credit bureaus for the purposes of sending you some sort of credit solicitation in the mail.
- A lender with whom you already have credit reviews your credit report.
- One of your credit card companies wants to re-issue your credit card before the expiration date.
- You have asked for a copy of your own credit reports, either directly from the credit bureaus or through one of the various online services that resell credit reports.
The common theme among these examples is that you did NOT proactively apply for any type of credit. These are all examples of when someone accessed your reports for a reason other than approving a credit application. These inquiries will show up on your credit reports for six months. Further, they are not displayed to any lenders who pull your credit reports. They are also not counted in any credit scoring models. Only you have access to see the list of soft inquires on your credit report. They are off limits to everyone else.
Sometimes these inquiries are called “promotional” or “account review” inquiries. This is an effort to differentiate them from their less consumer-friendly brethren, hard inquires.
Why do Inquiries Matter?
As with anything that makes it into your credit score calculation, a strong statistical correlation to your risk as a borrower is required.
Inquiries matter because they are the only way anyone knows if you are actively shopping for credit. They are also the way to measure if you are excessively shopping or not. If it weren’t for inquiries it would be impossible to know if and when you are credit shopping.
In fact, it is a proven fact that consumers who are actively looking for credit or have excessively shopped for credit in the past 12 months are a higher credit risk than consumers who have not.
But How Can I Get Credit If I Don’t Shop for Credit?
The simple answer is that you can’t. It’s impossible. Anytime you want to shop for a loan or apply for a credit card the lender is going to want to look at your credit reports and credit scores. When they do so it will post a hard inquiry, which can lower your credit scores.
And, when you want to shop around for the best loan rate, you could end up with multiple inquiries from multiple lenders. This is very common especially in the mortgage and auto lending environments. (Generally consumers will shop around for the best mortgage and auto loan interest rates.)
How Do Credit Reports & Credit Scores Treat the Act of Shopping Around for the Best Interest Rate?
In order to address this question, you have to split them up and examine changes in consumer credit shopping patterns over the past 20 years.
- Credit Reports: Here’s the bad news. Credit reports are nothing more than warehouses that store your credit histories. They don’t have a brain so they cannot distinguish between when someone is shopping for the best interest rate versus someone excessively shopping for credit. The two actually look very similar on a credit report. A lot of inquiries may be posted in a very short period of time and there’s no difference on the surface.
- Credit Scores: Here’s the good news. Credit scores are actually quite sophisticated and can be programmed to interpret credit data, specifically inquires, in an appropriate way. A smart credit scoring model will be programmed to read multiple inquiries in a short period of time as a consumer shopping around for a good deal on a car or mortgage loan and not a consumer applying for four or five separate loans.
A Little History
Here’s the bottom line. Think about how the credit landscape has changed in the past two decades. Twenty years ago the widespread access to lenders via the Internet was a fantasy. Consumers certainly didn’t shop around as aggressively as they do today. Now, you can actually apply for almost any loan at any time of the day or night right from the comfort of your own home and get an answer virtually immediately.
If the companies that developed credit scoring models wanted to treat consumers fairly they would be forced to adjust how their models treat the act of shopping for a loan. To their credit, they did exactly that.
It’s 1985 – Shawn wants to apply for a mortgage. He goes to his local bank or credit union and meets with the same person whom he’s borrowed from for years. He fills out paperwork and two months later he gets a decision as to whether or not he has been approved and at what interest rate. This process resulted in 1 inquiry being posted on his report.
It’s 2016 – Shawn wants to apply for a mortgage. He logs on to the Internet and goes to several bank and mortgage company websites where he applies to “pre-qualify” for a mortgage loan. In about two hours, he has guaranteed interest rate quotes from a half dozen lenders who are willing to overnight him paperwork to get his loan process started. This process resulted in six inquiries being posted on his reports.
Would it be fair to treat those inquiries the same way when they happened 20 years apart? Of course it wouldn’t. Shawn is still only going to have 1 loan regardless of how many inquires are on his credit reports. As such, the credit scoring industry had to change how they treated inquires to keep up with changes in how consumers shopped for credit.
Here’s what the industry did. They incorporated a process called “Inquiry De-duplication” into their scoring models. In English this means that they built a way to treat multiple inquires resulting from the act of shopping for one loan as one inquiry. The logic was actually quite simple and makes very good common sense. How can you tell if someone is shopping for a car loan or a mortgage? It’s very likely that all of the inquiries would be from auto lending companies or mortgage lenders, correct? It is also very likely that these inquiries would occur over a short period of time because consumers tend to shop for those items over a short timeframe.
FICO, the developer of the widely known FICO credit score, uses a 14-day to 45-day window for their de-duplication, depending on the model in use. As such, any inquiries that can be reasonably assumed to be from a car loan or mortgage application that occur in a 14-to-45-day window are treated as one inquiry in their scoring models. It doesn’t matter if you have 20 inquires. As long as they are from lenders who can grant auto or home loans AND they are all done in a that 14-to-45-day time period, they only count as one.
This de-dupe logic allows consumers to shop around for the best interest rate without having to worry about inquiries lowering their scores. It also removes any barriers preventing consumers from applying at many creditors, which is good for credit report and credit score sales. Certainly a smart move for the respective businesses since credit reporting agencies and credit score developers are paid each time a credit report and credit score is pulled by a lender.
How Do You Know If You Have Too Many Inquiries?
It’s the million-dollar question. How many inquires is too many?
There are two ways to tell if you have too many inquiries.
Score Factors: Each of your credit scores is accompanied by reasons why your score wasn’t higher. These are called “Score Factor Codes” or “Reason Codes.” There are generally four of these plain English explanations delivered with each score. If one of these four explanations is “you have too many inquiries” then you can be sure that your inquiries are hurting your credit score.
FACTA: FACTA is the acronym for the Fair and Accurate Credit Transactions Act. This act amended the Fair Credit Reporting Act in many ways. One of those ways is relevant to inquiries and their impact to your credit score. Even if your inquiries played a minor role in lowering your score you still have the right to know that. The following language is now a matter of federal law:
“If a key factor that adversely affects the credit score of a consumer consists of the number of enquiries (sic) made with respect to a consumer report, that factor shall be included in the disclosure.”
If you apply for a mortgage, then you will receive your credit reports, credit scores and all factors that adversely impacted those scores, including any impact of inquiries.
Ideally you want to have the fewest number of inquires. Here’s why.
How Long Will Hard Inquiries Hurt my Score?
Credit scores are a standard component used in today’s lending environment. Each of us has many different credit scores, generated from our credit reports from the three credit reporting agencies. It’s important to become familiar with the impact that inquiries have on your credit scores.
Each hard inquiry generally only costs you between 3-to-5 points. However, since your scores go down as your number of inquires goes up, it’s important to only apply for credit when you need it and not as a leisurely act. Inquiries generally stay on your credit report for 2 years. However, hard inquiries only affect your credit score for one year.
Find Out Where You Stand
As we mentioned, you can check your credit each month using Credit.ly credit report snapshot, updated every 14 days. This completely free tool will break down your credit score into sections and give you a grade for each. You’ll see, for example, how your payment history, debt and other factors affect your score, and you’ll get recommendations for steps you may want to consider to address problems. In addition, you’ll also find credit offers from lenders who may be willing to offer you credit. Remember, checking your own credit reports and scores is considered a soft inquiry — it does not affect your credit score in any way.