Effect of a Credit Inquiry on Creditworthiness

Traditionally, lenders have used a variety of different factors in determining your creditworthiness when you apply for an extension of credit. Lenders check your credit report to get an insight into your character from a borrowing perspective. You may have problems obtaining credit if you have a poor score but ironically, a lender can actually hurt your credit score simply by checking it.

Score

Equifax, Experian and TransUnion all compile consumer credit reports in the United States and each firm has its own credit-scoring formula. Nevertheless, each agency uses a scoring system that involves awarding you a score of between 300 and 850. High scores mean that you have a good credit history. According to FICO, or Fair Isaac, the firm that first developed the idea of credit scoring, a credit inquiry normally causes your credit score to drop by no more than five points. However, since many factors have an impact on your score, a credit inquiry has less of an effect on someone who has a lot credit activity than someone who has little or no credit history.

Multiple Inquiries

When you apply for a mortgage or a car loan, you may shop around for the best rate. If several inquiries appear on your credit report within just a few days, then the credit bureaus normally record this as one inquiry and do not penalize you for looking for the best deal. However, if you routinely apply for different kinds of credit, your score can drop more dramatically because credit bureaus assume that you are in desperate need of funds. According to FICO, people with six or more inquiries on their credit report are eight times more likely to go bankrupt than people with no credit inquiries on their report.

Types Of Inquiries

Only inquiries from creditors have an impact on your credit score and these are known as "hard inquiries." Soft inquiries do not hurt your credit score and these inquiries occur when you check your own score or when an employer checks your score as part of a background check. When a lender obtains a credit report from a credit agency, the report only factors in credit inquiries that occurred more than 30 days ago and some lenders even obtain reports that do not include credit inquiries from within the last 45 days.

Considerations

A credit inquiry that causes your score to drop by five points could prove costly if that score drop means you fall below the minimum credit score required in order to obtain a loan. However, paying your existing debts on time and keeping your overall debt levels low, can cause your score to rise and offset the damage of a credit inquiry. Aside from your credit score, your lender also factors in your income, the collateral you intend to use for the loan and the overall state of the economy before deciding whether to approve your credit application. Therefore, credit inquiries have a minimal impact on your overall creditworthiness.