Your credit score is an important part of your financial life. Good credit can help you qualify for loans and credit cards and secure lower interest rates on those loans. Poor credit can make it expensive to borrow money and make some lenders refuse to lend you any money at all.
Usually, when you apply for a loan or credit card, the lender looks at a copy of your credit report. This places an inquiry on your report, which drops your score by a few points.
Understanding the impact of credit inquiries and how long the impact lasts can help you manage your credit score while applying for loans.
Calculating Your Credit Score
Your credit score is a three-digit number that lenders can use to quickly gauge your trustworthiness as a borrower. Scores range from a low of 300 to a high of 850, with higher scores being better. Generally, anything above 760 is seen as an excellent score while scores above 700 are good.
There are three major credit bureaus: Experian, Equifax, and Transunion. Each tracks your interactions with debt and credit to build a credit report for you. Using the information on those reports, as well as a formula from FICO, they calculate your credit score, often called your FICO score.
There are five factors that affect your credit score.
1. Payment History
Your payment history is the most important part of your credit score, determining more than a third of it alone. It tracks your history of timely vs late and missed payments. Making timely payments helps your score. Missed and late payments hurt your score.
One missed or late payment has a much larger impact on your credit than a single timely payment, so it’s essential that you work to never miss a due date if you want to have good credit.
2. Credit Utilization
Your credit utilization measures two things, your total amount of debt and the amount of credit card debt you have in relation to your credit card’s combined limits. The less debt you have, the better it is for your credit score.
3. Length of Credit History
The length of your credit history is also composed of two factors. One is the total amount of time you’ve had access to credit. A longer credit history means more experience with debt, which can help your score.
The other is the average age of your credit accounts. Lenders prefer borrowers who stick with credit cards and loans over those who bounce from account to account. The older your average account, the better it will be for your score.
4. Credit Mix
The more different types of loans you’ve had, such as mortgages, auto loans, and student loans, the better it will be for your credit score. Dealing with different types of debt shows that you can handle all the different types of credit.
5. New Credit
New credit looks at both any new accounts that you’ve opened as well as new loans you’ve applied for. This is where credit inquiries appear on your report. Each inquiry can decrease your credit score slightly.
What Is a Credit Inquiry & How Long Does It Affect Your Credit?
When you apply for a new credit card or a loan, the lender wants to know whether you’ll repay your debts.
Typically the lender asks one or more of the credit bureaus to send a copy of your credit report. When a credit bureau receives the request, it makes a note of the inquiry on your credit report. Each credit inquiry decreases your score by a few points.
Credit inquiries reduce your score because applying for new loans on a regular basis can indicate a risky borrower. If someone asks a lender if they can borrow $25,000 to buy a car, that is a relatively reasonable request.
But if someone asks to borrow $25,000 for a car, then needs another $10,000 personal loan the next week, and $50,000 the week after that, and then a new credit card a day later, it can throw up red flags. The person might be sending in so many applications because they’re running into financial trouble or because they don’t plan to repay those debts.
A single inquiry on your credit report can reduce your score between five and 10 points. It’s not a huge impact, but it’s noticeable for someone who is right on the border between good and excellent credit or fair and good credit.
Each additional inquiry drops your score, so applying for multiple loans can cause your credit score to drop quickly.
The impact of each credit inquiry reduces over time. If the rest of your credit report is good, your score will return almost to normal within a few months. Inquiries completely fall off your report after two years.
Hard Inquiries vs. Soft Inquiries
When someone checks your credit report, it can place an inquiry on the report and drop your score. This can sound scary to people who use a credit monitoring service to keep an eye on their credit score.
The good news is that not every inquiry will hurt your credit score. When you apply for credit, lenders typically make something called a hard inquiry when asking the credit bureaus for a copy of your report. The bureaus take note of hard inquiries and put them on your credit report.
By contrast, soft inquiries are used by credit monitoring services or companies offering promotional credit offers or those helping you check if you’re pre-approved for certain products.
The credit bureaus don’t record soft inquiries into your credit, which means that soft inquiries have no effect on your credit score.
In simple terms, applying for a new loan or credit card usually involves a hard inquiry. Checking your credit without actually applying for a loan or credit card usually involves a soft inquiry.
What About Rate Shopping?
One of the best ways to save money on a loan — especially a large loan like a mortgage or an auto loan — is to shop around. If you get quotes from multiple lenders, you can choose the one with the lowest interest rate and fees to minimize your costs.
If each application results in a hard inquiry that hurts your credit score, rate shopping too extensively could damage your credit.
The good news for borrowers is that the FICO scoring formula accounts for the importance of rate shopping. For large loans like mortgages, auto loans, and student loans, all inquiries that occur within a short span — 14 to 45 days depending on the formula used — are treated as a single inquiry when calculating your score.
That means that you can safely compare rates from multiple lenders, as long as you get your quotes within a short period.
Applying for credit cards or loans can place credit inquiries on your credit report, which can drop your score. To make sure you keep your score healthy, do your best to only apply for loans that you need.
As long as you use your credit responsibly and don’t apply for too many accounts in a short period, you shouldn’t have to worry about the impact that inquiries have on your credit score.