The Difference between Hard and Soft Credit Inquiries
Consumers should be very concerned about their FICO scores because they have an influence on loan qualifications to purchase a home, automobile, insurance policy, phone service, and utility services. High and low FICO scores determine the interest rates applied to a loan once it is approved. What consumers may not know is that every time a business runs a credit check when applying for a loan, credit scores are reduced by a certain amount of points.
When a business requests for credit reports it is called “credit inquiries”, which are divided into two categories, hard inquiries, and soft inquiries. In this blog post, the following are discussed; different credit reporting agencies, FICO scores, and the difference between hard and soft credit inquiries.
There is no doubt that well-established credit is important when applying for student loans, credit cards, home loans, and car loans. Suppose a consumer needs an automobile and the only way to get it is to apply for a line of credit. Before the consumer’s application is approved, the dealership’s finance department, for an example, is required to inquire about the consumer’s credit history. In the United States, there are 3 major credit reporting agencies; Equifax, Experian, and TransUnion. Consumers can now request free copies of their credit report from each of those agencies by visiting www.annualcreditreport.com.
Every credit report has a cumulative score, whether the report comes from Equifax, Experian, or TransUnion. Each agency may have different scores and/or reporting credit information. That is why the Fair Credit Reporting Act (FCRA) was amended years ago that allows consumers to request a free credit report copy from all three agencies per year. The reports contain information pertaining to how bills are paid, court judgments, criminal background, and any filings for bankruptcy.
Credit scores are used by creditors to make an assessment of consumers’ ability to repay loans. Today, businesses, such as insurance carriers for auto and home, utility companies, and phone service providers pay agencies to retrieve credit reports that include FICO scores and credit history. The credit score includes a certain percentage of payment history, the amount owed to creditors, types of present credit used, and new credit. Payment history and the amount owed to creditors carry the highest percentage of weight for credit scores.
FICO credit scores are affected by the amount of debt still owed, slow payment history, creating additional new credit, and credit type such as secured and unsecured credit. Credit inquiries also have an impact on credit scores, as well. Credit inquiries are requested by companies to review the credit reporting of consumers to identity their potential risks. There are two types of credit inquiries as discussed earlier, hard and soft. The difference between the two is that soft inquiries have no effect on credit scores, whereas, hard inquiries do.
If consumers request their FICO scores for personal monitoring and reviewing, it is considered as a soft inquiry. Anytime commercial businesses promote services and products and check consumers’ credit status, there is no impact on the credit scores. Another example of a soft inquiry is when the company requests a credit check on a consumer who already has a credit account with them and needs an additional line of credit. Soft inquiries never have an impact on FICO scores, because creditors or lenders don’t review consumers’ complete credit history.
Hard inquiries are actual requests by creditors to review credit reports and the credit history of consumers applying for a loan. Examples of hard inquiries are when consumers apply for loans to purchase an automobile, furniture, house, etc. Each inquiry can reduce the FICO score by a few points. FICO scores can be reduced by 1 point up to more than 20 points. Consumers can eliminate lowering their credit score by avoiding applying for credit many times during a 45 day period. This usually happens to consumers when they are searching for apartments and rental properties.
Excessive applying for credit and apartment or rental properties within a certain period can definitely reduce FICO scores. Whenever consumers voluntarily give creditors and property management companies’ permission to check their credit, the FICO credit scoring system takes into account those hard inquiries. Credit inquiries consider factors, including the number of most recent inquiries, the time since an inquiry, the time since an account was recently opened by account type, and the number of the most recently opened accounts by account type. Credit scores are also affected when consumers don’t have established credit or have never applied for credit before.
Credit reporting agencies, like TransUnion and Experian, make available to consumers, creditors and lenders credit reports. Creditors and lenders are charged a fee to have access to consumers’ credit reports with permission by the consumer. There is a difference between hard and soft credit inquiries that businesses may request of consumers. Soft inquiries are harmless and have no ill effect on FICO scores, but hard inquiries will have a negative effect. FICO scores consider the amount of inquiries, consumers’ payment history, new credit, and the amount of debt still owed when determining a person’s FICO credit score.
What does that mean for you?
The terminology for when a potential lender or creditor checks into your credit history is called: “pulling your credit.” We’ve gone over the differences in the type of credit checks that are performed. One is known as a “soft inquiry” and the other as a “hard inquiry”. The Fair Credit Reporting Act places restrictions on exactly when and why credit reports may be pulled.
If you’re not careful, the inquiries that are made as a result of those credit or loan applications can drop your credit score, which in turn can result in higher interest rates for you. It’s almost like a Catch-22, unfortunately. On a large loan like a car loan or a mortgage loan, a drop of even a few points can mean you’ll pay a higher interest rate. Because of this, you may pay more over the life of the loan.
Applying for credit typically causes a small, temporary drop in your credit score. But having additional credit available to you may actually help your score overall because it can help your Credit Utilization Ratio (the amount of credit you are currently using compared with the amount available to you). You want to keep that ratio at no more than 30%.
There are a few ways to help minimize the likelihood that your credit score will drop when shopping around for new credit:
- Limit your loan shopping to a two-week period. If you do this, it’s likely those applications will only count as one single inquiry. That’s because most scoring models will count all inquiries of the same type as one inquiry. Try to keep the “shopping” within a 14 day period to minimize the risk.
- If looking for a new line of credit, consider going with a lender that you already have an account with. They’ve already pulled your credit once, so chances are they’ll just do a “soft inquiry” for your new line of credit with them.
- Being denied for credit can drop your score even more. It’s a smart idea to only apply for new credit if your score is 650 or above. Some creditors will allow 620, but with higher interest rates. Since you don’t know what the “cut-off” is, it’s best to apply if your credit score is greater than 650.
It can be hard to determine if something is going to be a soft inquiry or a hard inquiry. You can always ask the creditor or lender before they pull your report. Just ask them: “Is this going to be a hard inquiry on my credit or a soft one?” Then, you can decide if it is worth taking a few points off of your score. Always be an informed consumer when shopping for lowest rate loans or credit card offers. You have the right to “shop” around, but remember that any hard inquiries will result in a drop to your credit score.
If you need help obtaining your credit report or reviewing it, Advantage CCS offers a Credit Report Review service that can help you. Check it out here: https://www.advantageccs.org/services/credit-report-review