Your credit score is one of the most important aspects of your financial life. When a credit score is high, potential creditors such as credit card companies, mortgage lenders, and even employers feel confident in your ability to be responsible when managing money.
But when a credit score is low, creditors lack trust in you as a consumer and will offset the higher risk you represent by either increasing the cost of borrowing or declining your application altogether. While most are aware that a strong credit score is beneficial, many are confused as to what impacts a score positively or negatively.
Payment history is the most influential activity that helps comprise your credit score, which means making payments to creditors on time and in the full amount due. But one of the less commonly discussed aspects of a credit score calculation is the frequency of new creditor inquiries. Here we’ll break down how credit inquiries are categorized and what each means for your credit score.
Understanding Hard and Soft Inquiries
According to FICO, the leader in consumer credit scoring, 10% of a credit score calculation is based on new credit. This means that individuals who apply for new credit accounts or have their credit reviewed by a prospective lender often represent a higher risk than those who don’t do so frequently.
Trying to obtain new credit constantly makes creditors believe you may be in financial trouble – or you are about to increase your credit utilization significantly. While it is standard practice for a new creditor to pull a borrower’s credit report to evaluate risk, it is important to understand how these activities affect your score.
Hard Inquiry
A review of credit is known as a new inquiry on your credit report, and inquiries are categorized as either hard or soft. A hard credit inquiry is one in which a new application for credit has been requested, and a creditor pulls the applicant’s credit history and score in the evaluation process.
Examples of a hard credit inquiry include shopping for an auto loan, responding to a pre-approved personal or auto loan offer received in the mail or online, or requesting a credit line increase. With each of these requests, a hard inquiry is placed on your credit report.
Soft Inquiry
A soft inquiry, on the other hand, is when a credit report is viewed but not in response to an application for new credit. For instance, when you pull a copy of your own credit report or check your credit score through your bank or credit card company, a soft inquiry is added to your history. Similarly, an employer pulling credit history when a new job application is received is considered a soft inquiry.
Credit Report & Score Impact
Both hard and soft inquiries are included in your credit report and remain for two years, but your credit score calculation is only impacted by hard inquiries. When there are multiple hard inquiries from various creditors in a short period of time, your credit score may or may not be reduced to reflect the higher risk.
Fortunately, hard inquiries from similar creditors spanning a few days are often grouped together, like when you apply for a new auto loan or mortgage with multiple lenders to find the best interest rate or repayment terms. Hard inquiries that are grouped together have less of an impact on your credit score than inquiries that are spread out over multiple lenders for various credit needs.
Overall, the impact of hard inquiries is minimal to your credit score and history, but it is important to be careful with how many formal applications you submit and when. As a general rule of thumb, having only two or three inquiries for new credit over the course of 12 months is healthy for your credit score. Any more than that may represent a red flag for future creditors.
