Credit Inquiries

What is an Inquiry? An Inquiry is when a consumer's credit is reviewed by a lender, creditor, or by the consumer personally. Inquiries remain on the credit report for two years. Some types of inquiries will hurt credit scores, while others won't affect them at all. This seems to be where the most confusion comes into play. 

When a third party pulls credit with the consumer's authorization this inquiry will hurt the credit score. This type of inquiry is called a "hard pull". On the other hand, if a creditor pulls credit without authorization (for example, to consider a consumer for a promotional 2% credit card offer),  it is considered a "soft pull." A soft pull is an inquiry that does not negatively impact the credit score. But suppose the consumer applies for the promotional 2% credit card? The creditor will then undertake a more in-depth review, this time with authorization. This will be considered a hard pull, which will reduce the score. 

To understand inquiries we must look at scores as well. We will take the Fico Score as an example. The Fico Score is used by mortgage lenders when deciding a consumer's risk level. Based on the risk level, lenders decide what interest rate is appropriate for a loan or if a loan will be approved at all.   When lenders pull Fico Scores it is considered a hard inquiry and will impact the credit score. But Fico also sells scores directly to the general public online at www.myfico.com. Ordering your score and credit report directly from this site will not affect your score. No matter how often you pull your credit it will not affect your score. Consumers can also obtain their credit directly at other online sites, such as www.annualcreditreport.com, www.freecreditreport.com, www.Equifax.com,  etc. without hurting their credit scores. 

 "The impact from applying for credit will vary from person to person based on their unique credit histories. In general, credit inquiries have a small impact on one's FICO score. For most people, one additional credit inquiry will take less than five points off their FICO score. For perspective, the full range for FICO scores is 300-850. Inquiries can have a greater impact if you have few accounts or a short credit history. Large numbers of inquiries also mean greater risk. Statistically, people with six inquiries or more on their credit reports can be up to eight times more likely to declare bankruptcy than people with no inquiries on their reports. While inquiries often can play a part in assessing risk, they play a minor part. Much more important factors for your score are how timely you pay your bills and your overall debt burden as indicated on your credit report." -  www.myfico.com/CreditEducation/CreditInquiries.aspx

Mortgage underwriting has changed drastically since the economy entered the 2008 recession. Up until then you either had good credit or poor credit. Good credit was generally defined as having a FICO score greater than 660. With few exception everyone with a score 660 or better paid the same for financing. As the credit score dropped below 660 the cost of financing steadily increased. This is called risk based pricing. The lower the credit score was, the higher the risk of default so the cost for financing would increase to offset the lender's risk. One of the major changes in underwriting standards since the recession is that the concept of risk based pricing is now extended through the entire range of credit scores. The cost of financing for someone with a 720 score will be slightly greater than another person with a 740. As your credit score moves down the scale, your cost for funds increases until you reach a threshold where financing is simply not available. In today's lending environment even a small decrease in your credit score can increase your overall cost of credit.

Because of this it is essential to think about timing in managing your credit. If you are planning on applying for a mortgage within one - two years, every action that could affect your credit score should be weighed by the impact it will have. A home is one of the largest purchases a consumer will make in their lifetime, and the mortgage will be one of their largest monthly payments. You should do everything possible to get the best interest rate. You  are already making all your installment loan and credit card payments on time. You are keeping your credit card balances stable or maybe even slowly paying them down. You aren't taking on any unnecessary debt. You are doing all the right things. By staying aware of how inquiries can impact your score you will be able to keep your credit score 5 or 10 points higher. This slight improvement may be just enough to positively impact your cost for financing.

Let's look at how different inquiries happening at various times change a consumer's scores. When lenders pull credit scores through their pulling service (a third party between the bank and the credit reporting agencies- Experian, Trans Union, and Equifax) they are given merged reports. The reason inquiries have any impact in your credit score comes from the fact that your credit report only shows credit that is granted to you. It doesn't show if you were turned down for any form of credit. An inquiry, without credit being granted by the lender making the inquiry will happen due to one of two reasons. Either the lender turned down the credit application or the consumer elected not to accept the offer for credit. Nothing in your credit report will show why no new credit appears. The formula that determines your credit score addresses this issue by decreasing you score a little for every inquiry. Someone with a serious number of inquiries is probably having a hard time qualifying for a loan and that fact is reflected in a lower credit score. However, there is an expectation that consumers will shop several institutions when they are looking to make a large purchase such as a home or a car or applying for a student loan. To accommodate this, the formula treats multiple inquires for the same type of credit within a certain timeframe, called a window as one inquiry. This prevents a consumer from being penalized for doing the right thing of shopping for the best deal. What most people may not realize is that each bank chooses what "window" they will use to decide the effect of inquiries. Shopping for the best deal is the smart thing to do, but try to do it in the shortest timeframe since there is no way of knowing for sure what window the lenders are using at that particular time. Also keep in mind that each class of credit (mortgage, car loan and student loan) will have its own window.

For example:  Ed was shopping for the best rate on a mortgage.  He went to Bank of America on August 1st , Wells Fargo on August 3rd, HSBC on August 12th, and M&T on August 16th. Currently all of these banks had a 14 day window that they allowed for inquiries to be viewed as one. The three inquiries within the 14 day period only reduced Ed's score by 4-5 points but the inquiry that occurred on the 16th day, which was past the 14 day window, decreased his score another 4-5 points.  Ed's score was a 725 when he began and by the time he decided he wanted to get the loan 2 months later, after having his credit pulled yet again, his score was down to a 710. This results in Ed's cost of financing to be higher simply because of the tight window these lenders have elected to use in this credit environment.

During this time Ed also needed to go shopping for a new car. He went to a Toyota dealer, a Lexus dealer, and an Acura dealer looking for a car loan on August 5th, 10th, and 14th. This would have reduced his score another 4-5 points due to the tight timeframe of the inquiries.  But if he also increased his spending limit at Macy's on August 9th  that would reduce his score another 5 points.  Now we are talking about a 700 score. This is a major change in score and could make a huge difference in his loan rate.

Keep in mind that everything you do financially will impact you credit score. Some will improve your score like paying down your credit card debts. Other things will lower your score like applying for every card card offer that you are approached with. So be careful but don't become paranoid.  Remember there are hundreds of factors that are taken together to calculate your credit score and the most recent activity carries the most weight in the calculation. Stay aware, live up to your financial obligations and your credit score will take care of itself.