Barry Paperno is a freelance writer and credit scoring expert with decades of consumer credit industry experience, serving as consumer affairs manager for FICO (formerly Fair Isaac Corp.) and consumer operations manager for Experian. He writes “Speaking of Credit,” a weekly reader Q&A column about credit scoring and rebuilding credit, for CreditCards.com. His writings about credit scoring have appeared in The Huffington Post, MSN Money, CBS Money Watch and other consumer finance websites.
Dear Speaking of Credit,
What are the credit consequences of being denied credit? – Bo
In the days before modern credit scoring, more than 25 years ago, it could hurt. A lender who saw a hard inquiry on a credit report, and no corresponding credit card account being issued, would assume the application was denied. The assumption could then negatively influence the credit decision at hand.
Fortunately, these days, the only impact to an applicant’s credit score after being declined is the hard inquiry itself. All hard inquiries remain on credit reports for two years, with credit scores only considering them for the first year.
Credit scoring impacts from hard inquiries tend to be quite minimal – about five points, on average – such that the effect on your credit after being denied should be of little concern. Instead, what should be of major concern are the reasons why your credit was not considered good enough for approval.
In most credit denials, one or both of the following scoring categories that together make up about two-thirds of a score are at least partially to blame.
- Payment History: recent late payments.
- Amounts Owed: credit card balances making up a high proportion of the available credit (credit limit). Also known as credit utilization.
How do you know to what extent these and any other factors might be causing your credit to be rejected? Knowing how to use the following information lenders are required to provide you when declining your application can set you on the right rebuilding course.
To educate denied applicants on how credit works and on the various consumer-protections available, adverse action (credit denial) requirements were placed on lenders by the Equal Credit Opportunity Act, Fair Credit Reporting Act and Risk Based Pricing Rule.
An adverse action notice is sent any time an applicant has been:
- Denied new credit or has had credit revoked.
- Refused credit for the amount or terms requested.
- Given less-desirable terms following an unfavorable account review by a lender.
These adverse action notices, also referred to as denial letters, include:
- A free credit score, if a score was used in the credit decision.
- An offer of a free credit report from any credit bureau used to evaluate the application.
- An explanation of the consumer’s right to dispute the accuracy of information on a credit report.
When a credit score is included in an adverse action notice, the lender must also provide:
- The contact information for the credit bureau providing the data used for the score, the date of the score, and range of possible scores.
- A basic explanation of how credit scoring uses credit bureau report information to set the credit terms being offered, and how a credit score can change over time due to changes in the information.
- A list of the top four score factors – five if “too many inquiries” is one of them – having the most negative impacts on the score.
Of these free resources, the most useful tend to be the free credit report and those top four or five score factors provided along with your score that point out the scoring calculations most responsible for your score not being higher. The relative impact of these factors corresponds to the order in which they’re listed, such that the first listed is the most detrimental to your score, the second one is next in importance, etc. Knowing this can help you prioritize the actions necessary for a higher score.
A typical instance of how score factors can come to the rescue of a low score is where the first factor shown indicates your card balances are too high. By being first on the list of negative score factors, you know immediately that paying down those balance offers the greatest potential for score improvement.
Or, perhaps yours is this latter high-balance situation and the free credit report provided mistakenly shows an unpaid card balance on a card paid in full some time ago. After correctly diagnosing the problem and following the instructions for disputing credit reporting errors, thanks to the free report you can initiate an investigation at the credit bureau that, once completed, can have your score back where it should be.
As you can see, some of the consequences of being denied credit are really not so bad after all. In fact, considering the wealth of good information available for free after being declined, for some consumers denial of credit could mark the beginning of a score rebuilding opportunity that’s just what the doctor ordered.
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