I Caught You Looking!

Admit it -- while powdering your nose at a party you've peeked into the medicine cabinet for any telling curiosities. We can all excuse a little innocent snooping. (Mental note: Edit medicine cabinet contents before hosting next dinner party.) But it'd be a different story if you were caught flipping through your host's checkbook register or rifling through their wallet noting what credit cards they carry. Why, that'd be tantamount to... checking their credit file.

Do you really know who has taken a gander at your borrowing history? And do you care to guess what kind of effect such inquiries have on your overall credit score?

Obviously, applying for lines of credit for cars, homes, credit cards, and store charge cards will generate an inquiry in your file. And you can reasonably expect that your credit will be run by a new landlord and possibly a new employer. But there are some credit history inquiries that aren't necessarily initiated by the consumer.

Financing a car loan at the dealership might spark not just one, but a slew of inquiries into your file. Why? Some dealers shop multiple lenders to find the most competitive rate for customers. Hey, you'd do it, too, to find the best deal. (And you probably have approved several hits if you've shopped for a home loan, for instance, on a site that aggregates lenders and lets them compete for your business.) Even if you go through with just one loan, a comparison shopping trip can rock your credit file.

Another scenario that can generate an unknowing inquiry is when a spouse or family member applies for a joint loan. Including your name on the Best Buy credit card application may be his idea of "togetherness," but it may unnecessarily drag you and your credit file through the approval process.

What effect do these prying eyes have on your report? It is estimated that each "hard" inquiry can cause a five-point drop in your overall credit score. (Here's more about how that score is calculated.) The dip will most likely show up about three weeks after the lender takes his look into your file. The good news is that not every inquiry into your borrowing past will cost you five points. The credit reporting industry differentiates between "hard" and "soft" inquiries much the same way our girlfriends distinguish between a guy who's "relationship material" or just a fling.

When you check your own credit report (as you should at least once a year), for instance, it's a "soft" inquiry and may not even appear as a notation on your report. Credit background checks by an employer also have no effect. Checks by insurance carriers will most likely be counted as "soft" inquiries. Getting a pre-approved credit card offer does not harm your score. In that case, lenders access just a snippet of data from your file to see whether you would be a likely candidate for their card. But if you activate the card, the lender will take a much deeper look into your history and hit you with a "hard" inquiry. And you might not know it, but signing up for a cell-phone contract will result in a "hard" inquiry, although you can avoid it by going with a pay-as-you-go plan.

Unlike most credit-file entries (late payments, collections, judgments, bankruptcies), which linger in the fine print for seven years, credit inquiries have a shelf life of just two years. Even if you go on a credit application blitz, rest assured that you won't be reminded about it for too long.

Lenders also understand that sometimes consumers have to play the field, and they've designed the credit-scoring formula to factor in human behavior. Comparison-shopping trips over a short period of time -- three weeks or less (with some variance among the different scoring models) -- are bundled and have the same effect on your score as a single inquiry. That's why it pays to keep your inquiries contained. Here are some other tips on controlling hits to your file.

Plan your purchases: The number of yearly inquiries that are considered reasonable in the eyes of lenders is a bit vague. However, when you start getting up near six hard hits a year, you may notice a more significant drop in your score.

Go in with your own financing: You can avoid any unwanted dings at the car dealership by lining up your financing before you make a purchase. Competitive rates are everywhere, so shop around for the dough before you saunter into the dealership for your wheels.

Shop casually: Pull your own report (it generates only a soft inquiry) and examine your own credit report card before letting lenders formally pull your record. (We've lined up a special deal for Fool readers with TrueCredit, the consumer arm of TransUnion.) Your score will give you a general idea of what rates you'll likely be offered by lenders. After you narrow the field to the most competitive lenders, you can formally start the process.

Shop carefully: If you don't have stellar credit, make sure you know where you stand before generating even one hard inquiry. If your credit score is around 650, five or 10 points could make the difference between a good interest rate and a bad one. If you are not satisfied with the offers you qualify for, take a breather and work on improving your score. (Here are some pointers.)

Don't rush into a deal: Although the scoring model prefers that you keep your comparison-shopping excursion to three weeks or less, don't feel pressured to take the first decent loan you find. A 10- or 15-point drop that costs you just .2% on a small car loan isn't worth getting into a borrowing relationship you later regret.


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