Credit scores affect everything from a borrower's ability to buy a house to the interest rate he receives. A good credit score can save a savvy consumer thousands of dollars annually in interest charges. But the impact of specific action in relation to your credit score is difficult to discern, in part because the exact formulas that credit bureaus use have not been released to the public. According to Consumer Reports, a loan denial only has a slight negative impact on a credit score, because credit scoring agencies count the number of "inquiries" into credit, not the action of any specific lender toward a loan application.
Identification
The main credit scoring agency in the United States is the Fair Isaac Corp., better known by the acronym FICO. FICO maintains a proprietary formula that lenders and credit reporting agencies use to assign consumers a credit score, which ranges from 300 to 850. The higher the score, the more likely it is that a consumer will repay a loan. According to FICO, about 35 percent of a credit score is payment history, 30 percent is the amount a debtor owes, 15 percent is length of credit history, 10 percent is new credit and the remaining 10 percent is the type of credit used.
Considerations
Applying for new credit leads to, in the jargon of credit scores, an "inquiry." When a consumer applies for credit, she authorizes the credit card company to make an inquiry into her credit history. Multiple inquiries in a short time lower credit scores, FICO says. According to FICO "Statistically, people with six inquiries or more on their credit reports can be up to eight times more likely to declare bankruptcy than people with no inquiries on their reports."
Misconceptions
The idea that multiple inquiries lowers credit scores is controversial. Some believe it penalizes consumers for shopping around, which is seemingly a sign of a smart and responsible shopper. FICO says that the effect of inquiries is small. FICO's computer programs also take into account whether inquiries are related to mortgages or car loans, situations where a consumer is expected to shop around. In these cases, multiple inquiries might not be as frowned upon.
Significance
The effect of inquiries on credit scores in Fair Isaac's model falls under the category "new credit." That category accounts for approximately 10 percent of a credit score. A consumer who applies for a credit card, is denied, then applies for a different credit card is likely just digging a deeper hole.
Benefits
Better credit scores can save you tens of thousands of dollars when shopping for a home loan. FICO's website has a tool that allows consumers to view interest rates available for different credit profiles and compare monthly payments for any size loan. The site shows borrowers who have the highest credit scores might be able to get a 30-year, fixed-rate loan for $200,000 at 3.75 percent interest; they will pay $922 per month and $132,000 in interest over the life of a loan. By comparison, borrowers with lower scores might be able to get interest rates at 5.3 percent, so they would pay $1,111 per month and $199,000 in interest over the life of that same 30-year $200,000 loan.
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