How loan applications hurt your credit score
Expect a small, temporary impact from the 'hard inquiry' on your report
Credit Score Report
Dear Credit Score Report,
Let's say you go to your bank and request an application for a $50,000 home equity loan. The bank checks your credit and informs you that you are able to get this loan. However, you decide against the loan and do not follow through. How does this affect your credit score? I know there is such a thing as a "soft hit." What would this do to your credit rating? Please advise. Thank you. -- Marcy
That home equity loan application will result in a "hard hit" or "hard inquiry" and can impact your credit score, regardless of whether you actually get the loan. But don't worry: Any resulting score damage is likely to be minor and temporary.
When you apply for a home equity loan or another type of loan, the lender reviews the borrowing history listed on your credit report to determine whether you are a good loan risk or not. Whether or not you get approved for the loan, that credit check still results in a notation on your credit report. That notation is what separates a "hard hit" from a "soft hit." (For so-called "soft hits" -- such as when you check your own credit report for errors -- no such notation is made.) It signals that you are a borrower in search of credit and allows credit scoring models (and potential lenders) to treat you accordingly.
Since scoring models view a sudden desire for money as a possible sign of a borrower in financial trouble, your credit score may dip. However, as long as you've borrowed responsibly in the past and continue to do so, any credit score damage should be minor and your score will recover quickly. That means "there may be little or no impact in terms of her ability to qualify for other credit," says Rod Griffin, director of public education for credit bureau Experian.
Here's another way to visualize the difference between the two inquiry types: Imagine a hard inquiry as a pellet gun and a soft inquiry as a Nerf gun. A soft inquiry -- like the foam pellets from a Nerf gun -- just bounces off your credit report and causes no damage. A hard inquiry -- like a metallic BB -- may sting and leave a temporary mark, but it likely causes no real damage in the long run.
What kind of mark will it leave? "For most people, an additional inquiry will take about five points or less off of their score," says Barry Paperno, consumer operations manager at myFICO.com, the FICO score creator's consumer website. That's not enough of a drop to cause concern for most borrowers. Still, you can multiply the impact when you apply for several credit cards or loans around the same time. That's a good reason to avoid seeking credit you don't really need -- especially around the time you plan to apply for a major loan, such as a mortgage or car loan, where losing even a few credit score points could mean a higher interest rate.
A soft inquiry, meanwhile, is strictly performed for informational or promotional purposes. Since that type of credit check doesn't result in you taking on additional debt, your score won't be affected. A soft inquiry can occur in the following situations:
- When you review your credit report.
- When your existing bank takes a look at your credit report.
- When banks or businesses look at your report when deciding whether to prequalify you for certain marketing offers.
- When a potential employer checks your credit report as part of its hiring process.
- When an insurance company looks at your credit report.
In the scenario you describe, if you applied for the home equity loan, your credit score would indeed be impacted by a hard inquiry -- whether you continued with the loan request or not. However, you can apply for more than one home loan within a given time frame without increasing the score impact, which is not possible with multiple credit card applications.
As with mortgage or auto loans, the FICO scoring model recognizes that several home equity loan applications occurring close together suggest a borrower is looking for the best possible loan and will eventually choose just one. When multiple inquiries from home equity loan "applications are incurred within a short time, such as 45 days, they are treated as a single inquiry by the FICO formula," Paperno says. That's similar to how car loans are treated on your credit report. "For example, a consumer goes to six car dealerships within a 30-day period looking to buy a car and their credit report is pulled each time. This would be viewed as one hard inquiry to the consumer's credit report," says Cliff O'Neal, senior director of corporate communications for credit bureau TransUnion.
So what's the lesson here? As long as you always pay bills on time, keep debt levels low and apply for new credit only when absolutely necessary, your credit score isn't in any real danger from a hard inquiry. And if you aren't happy with the home equity loan terms offered by the first bank, from a scoring standpoint, it's usually safe to keep shopping.Good luck!
See related: 'Hard' inquiries have limited credit score impact, Free credit reports: How to get the actual free one, States stepping up to limit pre-employment credit checks, Insuring your car or home? Your credit history can cost you
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Updated: November 21, 2011
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