Credit Inquiries: What They Are (and How to Protect Your Score)

For consumers and small business owners alike, credit bureaus, credit reports, and credit scores can feel like one big, confusing puzzle.

What exactly goes into that all-important, 3-digit number known as your credit score?

Well, the short answer is this: A lot goes into it.

Some factors matter more than others, but every aspect of your credit score is worth knowing. That’s why we’re diving deep into credit inquiries.

What are credit inquiries, and why should you care about them? Well, here’s everything you need to know about credit inquiries and how they fit into your overall credit history.

What Goes into a Credit Score?

To get a full understanding of what credit inquiries really are—and how they affect your credit score—you need to first understand how they fit into the larger picture of your credit report.

Do you know what goes into your credit report? Unfortunately, a lot of borrowers are still in the dark about how their financial activities are reflected in their credit score or why they should even care about their personal or business credit score.

So, let’s take a few step back and break down what really makes up your credit score—and how credit inquiries fit into the larger puzzle of your credit report.

A Credit Report Explained

Your personal credit score is just a 3-digit number that sums up your financial history. But there’s a much larger story going on behind your credit score—and that’s your credit report.

Your credit report keeps track of the whole history of your financial life. Any debts you’ve owed, who you’ve owed, the track record of all your credit accounts—loans, lines of credit, credit cards, and so on.

Your credit report records all the ups and downs of your financial life, as told by the credit reporting bureaus: Equifax, Experian, and TransUnion. These 3 credit reporting bureaus gather your financial information, but do so differently and at different times.

What all 3 credit reporting bureaus have in common is the FICO algorithm. To keep things standardized, the 3 credit reporting bureaus use the FICO algorithm to calculate your credit score from the information on your credit report.

What Goes into the FICO Algorithm

The FICO algorithm weighs a few different pieces of credit data from your credit report to spit out that all-important 3-digit number. The end result is a prediction on FICO’s end—showing how likely you are to not pay back your debt within the next 18 months.  

The lower on the credit score scale you are, the more statistically likely you are to default on your debt. And on the brighter side of things, the higher your FICO score is, the less likely you are to default on a debt payment in the same time period.

Now, the FICO algorithm isn’t just random, of course. And while we don’t know exactly how the 3 credit reporting bureaus pull financial data and exactly how FICO comes up with your 3 different numbers, we do know the 5 major categories that have a heavy influence on your results.

When it comes to knowing the ins-and-outs of a credit score—and how to stay on top of yours—you need to know the 5 factors that the FICO algorithm deems the most important for determining your reliability as a borrower:

1. Payment history: Payment history takes up 35% of your credit score. It’s the single most important part of your score, so it’s a factor worth paying attention to.

Payment history has the most obvious impact on your credit score. Put simply, this part of your credit score keeps track of whether you pay your creditors on time and in full. The more credit accounts you have on file with on-time payment history, the better your score will be. It’s as simple as that. If you always pay your credit accounts on time and in full, you’ll have a strong credit score. If you frequently miss payments, your score will suffer. The amount you’re delinquent and the duration the payment is delinquent for has a large impact on how much a late payment can affect your score.   

2. Amounts owed: Amounts owed takes up the second most important slot in the FICO algorithm—coming in at 30% of your credit score. The amounts owed category reflects the total amount of credit you currently owe or have outstanding.

The most important part of nailing the amounts owed section on your credit report is understanding how credit utilization works. Your credit utilization ratio is important for your borrowing activity on your revolving credit lines, and shows the amount of currently outstanding debt relative to your total available credit limit. There is so much more that goes into a credit utilization ratio, but when it comes to keeping a great credit score, know this: Try to keep your credit utilization ratio above 0% but not more that 30% at any point in time.

3. Length of credit history: Up next is length of credit history, taking up about 15% of your credit score. Length of credit history is a self-explanatory credit category. When did you get your first credit card, student loan, or auto loan?

The first time you open a credit account, naturally, FICO won’t have much credit history on you. But that builds over time as you open credit accounts and develop a payment history. This category really impacts new borrowers—when you open your first credit account, your credit score will likely be low just because of length of credit history. But as you build your credit history, your credit score will keep going up as time goes on.

4. Credit mix: Your credit mix takes up 10% of your FICO score, and it reflects all the types of credit accounts you have in your credit report. Interestingly enough, the statistical likeliness that you pay on time can widely depend on the type of credit accounts you have open. For instance, borrowers are generally much more likely to pay auto loans and mortgage payments on time than they are on credit card debt.

So to give the most robust prediction on your risk and reliability to potential creditors, the FICO algorithm needs to take the different kinds of credit accounts you have open. In general, the more varied accounts you have open, the better you do in this category.

5. New credit: New credit takes up 10% of your credit score. For the purpose of understanding credit inquiries and how they affect your credit score, this is the category you should watch carefully. And because credit inquiries are at the crux of the new credit category, let’s start our deep dive into just how credit inquiries affect the new credit category—and what that means for your credit score.

How Do Credit Inquiries Come into Play?

When you fill out an application for a new credit account and send it a creditor’s way, the lender will almost always run a check on your credit report with at least one, if not all, of the credit reporting bureaus.

That means when you apply for a student loan, an auto loan, a business credit card, a mortgage, a small business loan, and so on, lenders will run credit inquiries. A credit inquiry can be both soft or hard—we’ll get into the difference in a moment. But in general, credit inquiries reveal your credit score and help a lender decide if you’re a trustworthy borrower.

Back to the new credit category. The new credit category comes into play when you apply for a credit account, and one or multiple credit inquiries happen. Credit inquiries always come before a new account is opened, and they tell FICO that you’re probably going to be borrowing via some type of credit account in the near future. That flag will create a new account on your credit report. There won’t be any credit history associated with that account—you haven’t used it yet, after all. So both the credit inquiry and the opening of a new account will ding your credit score.

Just how much do credit inquiries hurt your score? We’ll get into those details in a bit. But first, let’s cover the different types of credit inquiries out there.

The Different Types of Credit Inquiries Out There

When you come across the term “credit inquiries,” the first question to pop in your head should be, “What kind of credit inquiry?”

Because not all credit inquiries are created equal. First off, different people can perform credit inquiries on your credit report or score. Small business lenders, credit card issuers, potential employers, even you yourself, can perform credit inquiries on your report.

And FICO will determine how to weigh the credit check depending on the type of credit inquiry, why it was done, and who actually did it.

When it comes down to it, the difference in credit inquiries is broken down into “hard credit pulls” and “soft credit pulls.”

Soft Credit Inquiries

Soft credit inquiries—as the name suggests—aren’t as big of a deal in the greater scheme of your credit reporting history.

A soft credit inquiry refers to all credit inquiries where your credit is not being reviewed by a potential lender. (Although a lender or creditor could do a soft credit inquiry to check to see if you prequalify for a certain financial product. This saves time and money and for the lender—weeding out potential borrowers who are unqualified.)

A soft credit inquiry could be run for any of the following reasons: you want to check your own credit score, a business that’s offering you goods and services wants to check in on your credit, a credit card issuer or lender wants to check your score out for pre-approval, an employer wants to look at your financial history before hiring you, and so on.

Does This Count as a Soft Credit Pull?

To give you the full picture of what counts as a soft credit pull, here’s what to expect:

• Checking your own credit score? Almost always.

• Background checks for employers? Almost always.

• Pre-approval for loan and credit card offers? Almost always.

• Renting a car? Sometimes.

• Applying to rent an apartment? Sometimes.

• Identity verification by a financial institution? Sometimes.

• Opening a savings or checking account? Sometimes.

Think of soft credit inquiries as background checks. They are more informal looks into your credit report, and they can happen without your approval.

But what you need to know—and many don’t—is that soft credit inquiries do not affect your credit score.  

Hard Credit Inquiries

Hard credit inquiries, on the other hand, are one step up in the world of credit inquiries. Hard credit inquiries are considered serious inquiries made before you receive a business loan, a line of credit, a mortgage, or other major credit lines.

Most hard credit inquiries come from banks, credit card issuers, lenders, and other major financial institutions. And even if the lender ultimately turns you down, deciding not to extend you the credit, your credit report will still show a hard credit check.

Either way, really, hard credit inquiries are with you on your credit report for a period of time. Approval or non-approval, a hard credit inquiry will show for a maximum of 2 years. Just how it affects your credit score while it’s on your report requires some explanation—we’ll get to that below.

Does This Count as a Hard Credit Pull?

But first, when should you absolutely assume a hard credit inquiry will happen and your score will show it?

Well, here’s what to expect:

• Applying for an auto loan? Almost always.

• Applying for a small business loan? Almost always.

• Applying for a student loan? Almost always.

• Applying for a mortgage? Almost always.

• Applying for a personal or business credit card? Almost always.

• Applying to rent an apartment? Sometimes.

• Renting a car? Sometimes.

• Opening a checking, savings, or money market account? Sometimes.

• Requesting a credit limit increase? Sometimes.

• Getting a cell phone contract? Sometimes.

The thing to know about hard credit inquiries is, most importantly, that they do impact your credit score. But you’ll know when a hard credit inquiry is happening—you need to give permission for it to happen.

Credit Inquires: What They Mean for Your Credit Report and Credit Score

Now that we’ve walked through exactly what a credit inquiry really is, it’s time to get into the heart of the matter—and what you, as the borrower, really care about: how credit inquiries affect your credit score.

As it turns out, the impact of credit inquiries on credit reports and score can’t just be summed up in a single sentence. A lot goes into to credit inquiries and how FICO understands them.

Why Do Credit Inquiries Affect Your Credit Score?

Why are credit inquiries something that the credit reporting bureaus, FICO, lenders, and therefore you care about? What’s the big deal?

Well, after years of collecting data on borrowers’ financial histories, FICO’s research shows that opening several new credit accounts within a short period of time indicates greater risk—especially if the borrower in question doesn’t have a long credit history.

For instance, a borrower with 6 hard credit inquiries on their credit report is up to 8 times more likely to declare bankruptcy than a borrower with no hard credit inquiries on their report.

When you think about it, this makes sense: If you’re applying for serious credit lines in a short period of time, FICO and lenders might think that you’re desperate for credit or you can’t qualify for the credit you need.

How Do Credit Inquiries Affect Your Credit Score?

Hard credit inquiries are a reality for everyone’s financial life. They’re necessary for obtaining a home, a car, or growing your small business. And if you’ve just had a handful of hard credit inquiries throughout the years to do these things, you don’t have to sweat it.

One or two hard credit inquiries won’t significantly damage your score—at a maximum your credit score could fall 5 points. But lots of hard credit inquiries in a short period of time can seriously ding your score.

Which bodes the question, “What if I’m a smart borrower and want to shop around for the best rates? Won’t that result in a lot of hard credit inquiries in a short period of time?”

This is a great question, and one that speaks to the intricacies of exactly how hard credit pulls affect your credit score.

What you need to know is that FICO doesn’t weigh all hard credit inquiries equally. It depends on the circumstances of the hard credit pull and what kind of credit history you have going in the first place.

So fortunately, if you’re being a savvy borrower and shopping around for the lowest rate on a business loan or auto loan, FICO will take that into account. If you apply for the same type of credit account from multiple lenders within 30 days, FICO treats those credit inquiries as just one hard credit inquiry. FICO calls this activity “rate shopping.”

This goes to show that credit inquiries and how they affect your credit score aren’t black and white. In general, the worse your credit report already is, or the younger your credit history is, the bigger impact hard credit inquiries will have. But if you’ve always practiced tip-top borrowing behavior and have a great credit history to show it, you don’t really have to worry about a hard credit inquiry.

Which begs another question: How long—if at all—do you have to worry about credit inquiries showing up on your report?

How Long Do Credit Inquiries Affect Your Credit Score?

Hard credit inquiries—unlike soft credit inquiries—do show up on your credit report, and potential lenders will be able to see them for some time.

At a maximum, a hard credit inquiry will stay on your credit report for 2 years. But they only impact your credit score for a maximum of 12 months. And usually, the impact lasts for just 6 months after the inquiry happened—if it brings your score down at all.

Best practice is to wait out a hard credit inquiry and take up good borrowing habits in the meantime. Payments history and amounts owed are much more important factors for your credit score in the long run, so focus on these categories and wait until your hard credit inquiry is off your report.

Can You Remove a Credit Inquiry?

As we mentioned before, a hard credit inquiry legally can only happen with your permission. But in the off-chance that your credit score is dinged for a hard credit check you didn’t authorize, you can dispute a hard credit inquiry on your report.

First, obtain a copy of your credit report and check to see which creditor performed an unauthorized credit report. You can call the creditor and actually ask why the inquiry was run. Just look for the creditor’s information in the inquiry section of your credit report.

You can also contact the credit bureau and get more detailed information from them. They should be able to help you get the hard credit inquiry off your report. And if not, go and file an official dispute by calling the bureau or mailing a letter.

Credit Inquiries: The Key Takeaways

When it comes down to it, what do you really need to know about credit inquiries and your credit score?

Well, the important takeaways are this:

• Hard credit inquiries usually don’t have a huge impact on your credit score, so there’s no need to worry too much about them. Just avoid opening a bunch of credit accounts in a short period of time, and you should be golden.

• Best practice is to keep your hard credit inquiries to one or two pulls a year if they’re totally necessary. And when you do pull your credit, take some time to seriously consider whether you need the credit and if you’re ready to use it appropriately.

• Don’t sweat “rate shopping.” It’s important to get the lowest interest rate you can on a loan or mortgage, so remember that FICO won’t ding you for shopping around for your best option.

Credit inquiries are just a small fraction of a very important larger picture—your credit report. Remember that everything in your financial history adds up!

So while a few credit inquiries here and there won’t hurt you in the long run, keep track of what’s going on with your credit inquiries at all times. Monitoring your credit and keeping up with your credit accounts are key ways to win the credit score game.

 

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from Fundera Ledger https://www.fundera.com/blog/credit-inquiries