When it comes to applying for a loan or a credit card, it seems like there are a lot of rules that nobody ever teaches you. One of the most important relates to how credit checks can affect your credit score.
First of all, it’s important to clarify the difference between a credit report and a credit score. The credit report shows your history with credit, such as credit card bills, mortgage payments, car loans, and credit checks/inquiries. The credit score, on the other hand, is a number that summarizes your credit worthiness. Fortunately, there are two kinds of credit inquiries, and only one is harmful to your credit score.
Hard inquiries are inquiries by a potential lender or financial institution. This kind of credit check is necessary when you’re hoping to qualify for an auto loan, credit card, or mortgage. It’s only a hard inquiry if you initiated it by applying for credit. Any other inquiry is a soft inquiry.
Soft inquiries are any checks requested by potential employers, potential landlords, credit card companies sending pre-approved offers, and many more. The difference is that you aren’t applying for credit or initiating the inquiry yourself. Instead, people entering into a business relationship with you are checking to see how you conduct your finances, which will help them decide if you’re a safe bet or not.
What It All Means
Remember that the reason for all of this is to help others assess how much of a financial risk you would pose in a business relationship. In the old days, you might live in a small town where the local banker had personal relationships with the rest of the town and knew firsthand who was a good risk. Today, lending institutions use the credit report and score as a way to judge the same thing.
Every hard inquiry represents an instance where you sought credit. If you are initiating a lot of applications for loans or credit cards, that could mean you’re in serious financial trouble, and your score will drop accordingly. Fortunately, the system is set up to allow you to shop around for the best rate on a mortgage or auto loan. It treats those searches as a single inquiry if they’re all conducted in the same short time window.
In the end, credit inquiries only account for 10% of your credit score. While it’s a good idea to be mindful of credit checks, don’t let it rule your life. As long as you keep meeting your financial obligations and conduct your finances wisely, your credit score should be just fine.
David Silverstone is a veteran financial writer and credit enthusiast. He is a contributing columnist at Credit Card Insider, the leading provider of unbiased consumer and business credit card selection and discovery resources. You can find more of his work on The Insider Blog.