How Credit Scores Are Built – Part Five
Did you know that shopping for new financing might hurt your credit scores? One of the most controversial topics when it comes to credit scoring is that fact that allowing lenders to pull your credit can potentially have a damaging impact upon your credit scores. As a result, of the 5 categories of credit report information which are used to make up your FICO scores there is no other category which causes consumers more frustration than the “New Credit Category.”
The final category of credit report information which will be covered in this series is referred to as “New Credit.” Thankfully the category only accounts for a small 10% of your FICO credit scores. Yet as mentioned in the previous article in this series, 10% can equal up to 55 points – much too high of a number to be ignored.
FICO’s credit scoring models are built to pay attention to how often you apply for new credit. Why? Applying for or opening too much new credit within a short period of time can indicate that you are a higher credit risk to future lenders. Unfortunately from a lender’s perspective the more accounts you open the greater your chances of defaulting on those obligations, especially new accounts where you have not had an opportunity to prove yourself yet.
What Is an Inquiry?
Whenever you fill out a new loan application and a lender pulls a copy of your credit a record of that pull, known as an inquiry, is left behind on your credit reports. Inquiries can occur anytime that you or someone else obtains a copy of any of your 3 credit reports. According to the Fair Credit Reporting Act (FCRA) the credit bureaus are required to document every single time any your credit reports are accessed, a requirement created because you have the right to know when someone has been looking at your personal credit information.
Hard and Soft Inquiries
Not all inquiries are created equal. That is good news. FICO understands this fact builds its credit scoring models to differentiate between credit pulls which occurred because you were applying for new credit and credit pulls which occurred because you were checking up on your own reports. These 2 different types of inquiries are referred to as “soft” and “hard.”
Soft inquiries will never impact your credit scores. These types of inquiries show up whenever you check a copy of your own credit reports for review purposes. As a result, you never have to be worried about pulling your own credit. The idea that checking your personal credit could hurt your scores is a complete myth and a dangerous one because the truth is that you should be checking your reports often for errors.
Hard inquiries are another story. These types of inquiries generally occur when a lender is pulling your reports as part of an application for financing or services. Not every hard inquiry will damage your credit scores, that is a myth as well, however all hard inquiries do at least have the potential to cause some harm.
Even when hard inquiries do have a negative impact upon your credit scores there is still a bit of a bright side. FICO only considers hard inquiries for 12 months. Once a hard inquiry is older than a year it is completely ignored and no longer has any ability to damage your credit scores.
FICO will take a look at a number of different factors when reviewing the “New Credit” category of your reports. Here is a list to help you understand a few of the most important credit report details which are weighed within this category.
- How Many New Credit Accounts You Have Opened (By Each Type of Account)
- How Many Inquiries Within the Last 12 Months
- Length of Time Since Credit Inquiries Were Made
- How Long Since You Have Opened a New Credit Account
Food for Thought
Just because a hard inquiry might have the ability to damage your credit scores does not at all mean that you need to be afraid to apply for new credit.
A few inquiries per year, especially if they are spaced out, are probably going to have very little impact upon your scores. On the other hand, applying for credit frequently or just because you want to save 20% off your purchase at the mall is probably a practice which is best avoided.