If you’ve ever checked your credit score before and after applying for a loan or credit card, you may have noticed it dropped a little bit. Yes, applying for credit hurts your credit score, but it’s usually a small hit, and it won’t drag you down for long.
This is because applying for new credit results in a hard inquiry on your credit report, and credit scores view hard inquiries as a slightly negative bit of credit history. Hard inquiries are pretty straightforward, but understanding why they’re bad takes some explaining. First, you need to understand the difference between a soft inquiry and a hard inquiry.
What Are Inquiries?
Whenever someone looks at your credit report, it’s noted in your credit history. There are many reasons to pull a credit report: You do it to make sure everything in your history is accurate, monitor for signs of fraud and understand how a potential creditor may view you; lenders look at consumer credit reports when deciding to whom they should send offers; an employer may check your credit history as a part of the job-offer process — there are a variety of situations in which someone may want to review your credit history for something other than granting you a loan, and those informational requests are called soft inquiries. Soft inquiries have no effect on your credit scores.
It’s when you’re asking someone to take a risk and extend you credit that an inquiry has a negative impact on your credit standing.
Why Is Applying for Credit Bad for Scores?
This isn’t to say you should never apply for new credit, but it’s definitely something to do sparingly and cautiously. Applying for a new credit card is only going to shave off a handful of points from your credit scores, and that effect only lasts for about a year (inquiries stay on credit reports for two years, but most scoring models ignore inquiries older than a year). In addition to the damage being only temporary, the benefit of the new credit (if you receive it) will likely outweigh the few points you lost to the inquiry, because things like account mix and available credit relative to your debt matter more than inquiries.
Don’t underestimate those hard inquiries, though. If you apply for a lot of new credit in a short time frame, those little dings in your credit score will add up. Think of it from the lender’s perspective: Someone who is suddenly shopping around for a lot of credit may be doing so to cover a shortage in cash. That could indicate potential trouble repaying debts, which makes the consumer a credit risk. The drop in credit score resulting from many hard inquiries reflects that risk.
There are some exceptions to the “apply sparingly” rule: When searching for a mortgage, auto loan or student loan, most credit scoring models allow you at least a two-week period to apply for multiple loans of the same kind, so you can find the best deal. For example, if you’re shopping for the best mortgage pricing, any mortgage inquiries made within two weeks will count as a single hard inquiry — this encourages consumers to seek the most affordable deal, without having to worry about harming their credit standing.
In many cases, credit score shifts of a few points won’t matter much, but with large loans like mortgages or auto loans, small score changes could cost you thousands of dollars over the life of the loan. That’s why it’s important to apply for credit only when you need it, abstain from getting new credit in the months leading up to submitting a home- or auto-loan application and regularly monitor your credit scores and reports to make sure errors don’t adversely affect your chances at securing affordable financing. You can get a free credit report summary every 30 days on Credit.com to help you stay organized and informed.
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- How to Get Your Free Annual Credit Reports
This article originally appeared on Credit.com.
This article by Christine DiGangi was distributed by the Personal Finance Syndication Network.