Can Applying for Loans Hurt Your Credit?

Applying for a new loan can bring up questions about its potential effects on your financial standing. This article clarifies the mechanics behind loan applications and their relationship with your credit score.

Understanding Credit Inquiries

When you apply for credit, such as a loan or a new credit card, lenders often request to view your credit report. This action is recorded as a “credit inquiry.” There are two primary types of credit inquiries: hard inquiries and soft inquiries. Understanding the distinction between these two is important because only one type impacts your credit score.

A hard inquiry occurs when a lender checks your credit report as part of a formal application for new credit. Examples include applying for a mortgage, an auto loan, a personal loan, or a new credit card.

In contrast, a soft inquiry happens when your credit report is accessed without you formally applying for new credit. This can occur when you check your own credit score or report, or when a lender pre-approves you for an offer. Soft inquiries may also happen when existing creditors review your account or for background checks. Soft inquiries do not affect your credit score.

Impact of Loan Applications on Your Credit Score

Hard inquiries, which result from loan applications, can cause a minor and temporary dip in your credit score. The impact is generally small, often reducing a score by fewer than five points for most individuals. This slight decrease is typically short-lived, with scores often recovering within a few months if you maintain responsible credit behavior, such as making timely payments.

While a hard inquiry remains on your credit report for up to two years, its influence on your credit score is usually limited to a shorter period. Credit scoring models, such as those from FICO, generally consider inquiries from only the most recent 12 months when calculating scores. Inquiries are only one component of credit scoring models, carrying less weight compared to factors like payment history and credit utilization, which have a more substantial effect.

Specific Loan Application Scenarios

The way credit scoring models treat multiple inquiries can vary depending on the type of loan being sought. For certain major loans, like mortgages, auto loans, and student loans, credit scoring models typically account for “rate shopping.” This means that multiple inquiries made within a concentrated timeframe are often treated as a single inquiry. This allows consumers to compare offers from various lenders without their scores being penalized for each separate inquiry.

The specific timeframe for this rate shopping window commonly ranges from 14 to 45 days, depending on the credit scoring model. This contrasts with applications for personal loans or credit cards, where each hard inquiry is generally counted individually, potentially leading to a separate, albeit small, impact on your score for each application.

Reviewing Your Credit Report After Applications

After applying for a loan, it is prudent to review your credit report to see how inquiries are recorded. You are entitled to a free copy of your credit report once every 12 months from each of the three major nationwide credit bureaus: Equifax, Experian, and TransUnion. You can access these reports through AnnualCreditReport.com.

When you review your report, each inquiry will typically include the date the inquiry was made and the name of the lender or company that requested your credit information. It is important to check these details for accuracy and to ensure that all inquiries listed are legitimate and correspond to applications you initiated. An unrecognized inquiry could indicate potential identity theft or an error that should be disputed with the credit bureau.