Credit Checks Can Be Less Harmful Than You Think

Many people will go out of their way to avoid inquiries on their credit, but it may not be as big of a deal as you think. Only certain types of inquiries count when determining your score, the weight of inquiries in the scoring formula is very low, and there are some special rules designed to make it easier to shop around for the best interest rates without your score dropping.

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Here are three things you need to know about credit inquiries and how they affect your score.

How much do inquiries matter, and why do they count at all?
Most lenders use the FICO scoring formula, and 10% of your FICO score comes from a category called "new credit."

This not only includes credit inquiries, but also takes into account the number of new accounts you've opened recently. It seems like actually opening a new credit account is more important to your overall credit profile than simply applying for one. So, while the actual FICO formula is a well-kept secret, it's pretty safe to say that inquiries account for a fraction of that 10%.

So, why do they count inquiries at all? Fair Isaac's (the company that produces the FICO score) research shows that opening several new credit accounts in a short time period is indicative of higher credit risk. Some people take out new credit because they are struggling to pay their living expenses, so it makes sense to some extent. Applying for several new credit lines can indicate a "desperate" need for credit, so your score could drop as a result.

But it's only certain kinds...
There are two main types of credit inquiries: hard inquiries and soft inquiries. Hard inquiries are the kind that counts in the FICO formula, so it's very important to know the difference.

Soft inquiries include "consumer-initiated" requests, such as when you check your own credit report, or access it through a credit monitoring service. It also includes "administrative inquiries", which occur when lenders look at your credit for the purposes of reviewing your existing accounts.

flickr/ Steve Spinks

And, "promotional inquiries" are also soft inquiries, and are made by lenders before they offer you pre-approved credit. It's also worth noting that although soft inquiries don't count, you can see them when accessing your own credit file.

So, the only types of credit inquiries that the scoring formula takes into account are inquiries you authorize for the purpose of applying for new credit.

You are free to shop around
A common misconception is that every loan application you fill out counts as an inquiry on your credit, and because of this, many people only apply to one mortgage or auto lender.

However, the scoring system actually encourages you to shop around to find the best rate. When shopping for a mortgage, auto loan, or student loan, any inquiries that occur within a "typical shopping period" only count as one single inquiry and should lower most peoples' scores by less than five points, according to Fair Isaac.

A typical shopping period is wither two weeks or 45 days, depending on whether the lender uses a newer or older version of the scoring formula, so to be safe try to do all of your rate shopping within the shorter timeframe.

Recent inquiries also won't lower your credit score during the shopping process. Let's say you're shopping for a car, and you apply to five different lenders within a two week period. Well, we've already seen that this will count as just one inquiry.

However, inquiries when applying for these loan types don't count until they are more than 30 days old in order to prevent your score from dropping simply because you're shopping for a rate. Once the 30 day window has passed, the single inquiry will appear on your credit, but will most likely affect your score minimally, if at all.

Be careful, but not too careful
The point here is that credit inquiries don't really have much of an impact on your score as long as you aren't irresponsible with them. For example, credit card applications are not subject to the "one inquiry" rule, so if you apply for eight credit cards, expect to see eight individual inquiries show up on your report, which is sure to affect your score.

However, don't be afraid to apply and shop around for new "good" credit like mortgages just out of fear of inquiries lowering your credit score. As long as you use common sense, and apply for new credit only when you need it, inquiries shouldn't be much of a concern to you.

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