You’ve read here before about the five factors that directly affect credit scores, more specially, FICO scores calculated for mortgage loans. The FICO Company developed the original algorithm credit agencies use to come up with the three digit score ranging from 300 to 850. Today, mortgage programs typically require a minimum score for a loan approval based upon the type of loan, down payment and other factors.
The five factors used to calculate the credit score are:
- Payment History- This accounts for 35% of the score and reflects recent payment patterns and any payments made more than 30, 60 and 90 days past the due date.
- Available Credit- Contributing 30% to the score compares current loan balances with credit lines. The closer the account balance gets to the credit limit, scores will falter. Going over the credit limit, even temporarily, will cause scores to fall further still.
- Length of Credit- This is simply how long someone has used credit. The longer the credit history the better. 15%.
- Types of Credit- This reviews various types of credit accounts such as a car loan, credit card and student loan accounting for 10% of the score.
- Credit Inquiries- This counts the number of times a creditor has checked your credit and contributes 10% to the score.
Inquiries Explained
One of the first things your loan officer will ask of you is to not apply for any other credit while your loan is being processed. A credit inquiry is a direct request for a credit history. This request makes sure your credit file is essentially the same when your loan papers are drawn compared to the time the lender first pulled your report. If there is a large discrepancy, such as a new credit account, the loan will have to be reviewed once again and papers redrawn.
There are three types of recognized credit inquiries. One is where you request a copy of your credit report on your own. It’s good advice to check your credit once per year in case there are any mistakes that appear on your report, which unfortunately happens more than you might think.
The next type of inquiry is what is referred to as a “soft” inquiry. A soft inquiry can occur with or without your knowing but does not affect a credit score. For example, you’re applying for a job and the potential employer requires a review of your credit history as part of a background check. Or, you’ve received a credit card offer because your profile fits the creditor’s requirements. Again, these inquiries do nothing to your score.
A hard inquiry is the type that can affect your credit score. A hard inquiry is a direct request from a third party as the result of your applying for a credit account. For example, you do receive a credit card offer in the mail. You decide you want to open an account so you apply online and give the creditor permission to pull your credit. This is a hard inquiry. It’s a direct request for an extension of credit by the consumer.
The Impact of Multiple Credit Inquiries
So if credit inquiries only account for 10%, should you be concerned with applying for credit due to the impact it will have on your score? A single request for credit will directly affect your score but only by about five points or so. However, recent, multiple requests for credit can indicate the individual is experiencing some difficult financial or employment issues and applying for credit accounts due to the loss of income or a potential loss of job. Multiple requests for different types of credit indicate problems ahead and scores can really begin to tumble.
However, when applying for the same type of credit for the same purpose over a short period of time, the credit scoring algorithm takes into consideration that consumers aren’t getting in over their heads but shopping around for the best deal and has no effect on the score as long as the inquiries are made within a specified period of time. According to the Consumer Financial Protection Bureau, your scores will remain the same despite multiple hard requests. How long is this window? The CFPB states if the queries are made within a 45 day period, all for the same credit account, the scores will not be affected.
For example, if you’re shopping for a new car and visit more than one dealership, you could apply for credit at each dealer. Even if you shop around for an entire month and visit several dealerships as long as the credit inquiry is for the same purpose your scores won’t be affected.
However, if during that same time you’re shopping for a car and a car loan you also apply for two different credit cards and want to finance a new sofa, those are hard inquiries for different purposes. That will cause scores to suffer.
Mortgage Loans and Credit Inquiries
Consumers who are shopping for a mortgage might also be concerned about making multiple credit inquiries but just as the scenario when shopping for a car, your scores will remain the same. Speaking with two, three or even four lenders and applying for a mortgage and your scores are pulled by each lender, because it’s for the same purpose your scores will be fine.
One final note about credit inquiries and mortgage loans. Let’s say you applied for credit at a furniture store but decided not to buy that sofa after all. Or, you applied for a car loan but figured you’d keep driving your current one for another year or two. Still, your credit report will reflect a hard inquiry. Now, your lender needs more information from you.
Because payment histories are updated every 30 days, while a credit inquiry will show up almost immediately the mortgage lender doesn’t know if you took out a new loan or not because the invisible creditor has yet to report any payment history. For all the lender knows, you applied for a brand new luxury SUV and your monthly payments are $850 per month. If so, your debt ratios could be too high for a loan approval.
That’s why your loan officer asks that you stand pat as it relates to any new credit because of this reporting gap. The lender sees an inquiry but has no documentation about the account. And in this instance, the lender will err on the side of caution and ask for further documentation from you about the hard request.
