Why hard inquiries hurt your credit score
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Dear Speaking of Credit,
Why does my credit score go down when hit by hard inquiry? -- Chad
Though only making up a small portion of your score, inquiries have become something of a lightning rod for credit scoring questions, misinformation and worry. For most of the people I've talked to about credit scoring over the years, there appears to be a clear understanding and acceptance of the fact that how you pay, how much you owe and the length of time you've been using credit should impact your credit score. There even seems to be agreement with the way in which the score can take a hit when a new credit account is added to a credit report.
But seeing a score drop for no other reason than a creditor has simply "inquired" into your credit history? For many this just doesn't seem to make any sense. So I'll explain.
An inquiry is a notation added to your credit report for your protection any time the information in your credit report is reviewed by anyone for any reason within the limits established by the Fair Credit Reporting Act. This notation includes the date and name of the company viewing your credit file, along with an identifying "subscriber code" indicating the kind of business -- bank, mortgage company, auto lender, etc. -- making the inquiry. From this information the credit scoring formula determines whether to consider or ignore the inquiry within a credit score.
There are two main types of inquiries -- "hard" and "soft" -- that are differentiated according to the reason for the credit "pull." Hard inquiries are usually initiated by the consumer as part of an application for credit and are included in credit scores, while soft inquiries most often occur without the consumer's prior knowledge and are excluded from scoring. All inquiries remain on a credit report for two years, with none included in a credit score after the first year.
Hard inquiries most often result from:
- Applications for new credit cards and loans.
- Accepted credit offers.
- Credit limit increase requests on existing cards.
- Apartment and house rental applications.
- Collection agencies attempting to locate missing debtors (skip tracing).
Soft inquiries are likely to appear on a consumer's credit file when:
- Lenders periodically review the credit standing of their existing borrowers to decide on credit limit increases, additional credit product offers and whether to renew cards or allow them to expire.
- Prescreened offers of credit are made to consumers who do not already have a business relationship with the inquiring lender.
- Insurance companies access credit reports to calculate credit-based insurance scores.
- Credit information is used to place consumers on marketing mail lists.
- Consumers access their own credit reports or scores.
One last note about hard inquiries is that for the types of credit applications where it's customary to shop for the best interest rate -- mortgage and auto loans, particularly -- multiple inquiries incurred over a focused period of time, such as 45 days for newer scoring models, are treated as a single inquiry by the scoring formula.
Now that we know a soft from a hard inquiry, let's take a look at why the scoring formula should even care that someone has looked at your credit. After all, what does having your credit pulled, for whatever reason, have to do with the factors most commonly associated with evaluating creditworthiness: How you pay, how much you owe and how long you've been using credit?
Most of us seem to be comfortable with the kind of thinking that says if you have managed to keep your card balances low and have a history of on time payments, you are more likely to continue doing so in the future than someone who has managed credit poorly. What is not so obvious is that the same research leading to the above logic has also shown that consumers with recently opened credit accounts are more likely to make late payments in the future than consumers without new accounts on their credit reports. And since an instantly appearing inquiry is generated every time a consumer's credit report is pulled prior to a new account opening -- often as much as 30 days before the account appears on the credit report -- the scoring formula is simply taking advantage of this early warning feature when a score takes a slight dip following the addition of a hard inquiry.
Still, when acknowledging the risk predicting value of inquiries, it's important to keep their impact on scores in proper perspective. Within the bigger scoring picture, the impact of inquiries remains relatively minimal by typically making up less than 10 percent of a credit score. In contrast, the scoring factors we're most familiar with and accept -- payment history and amounts owed -- account for 35 percent and 30 percent, respectively.
Keeping all this in mind, if you're looking for some simple guidelines for managing the number of inquiries on your credit report, figure that if you have a good score you don't have to worry about an occasional new inquiry from a new credit application or acceptance of a credit offer. If, on the other hand, you have a low or average score, your best bet is to avoid lowering it further by applying for new credit, requesting credit limit increases or accepting new credit offers. Instead, focus on raising your score by continuing to pay your existing accounts on time and maintaining the lowest card balances possible.
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