Does a Loan Application Affect Your Credit Score?
Understand how applying for a loan influences your credit score, covering both the immediate impact and subsequent profile changes.
A credit score is a numerical representation of an individual’s creditworthiness, typically a three-digit number ranging from 300 to 850. Lenders use this score to assess the likelihood of a borrower repaying debts on time. It predicts credit behavior, influencing decisions on loan approvals, credit card applications, and interest rates. A higher score generally indicates lower risk to lenders, potentially leading to more favorable loan terms.
How Loan Applications Appear on Your Credit Report
When you apply for a loan or credit, the inquiry appears on your credit report. There are two main types: soft inquiries and hard inquiries. Understanding their difference is important for managing your credit profile.
Soft inquiries, also known as “soft pulls,” occur when a person or company checks your credit report without you formally applying for new credit. Examples include checking your own credit score, pre-approved credit card offers, or when an employer reviews your credit for a background check. These inquiries are visible only to you and do not impact your credit score.
Conversely, hard inquiries, also known as “hard pulls,” happen when a lender accesses your credit report as part of a formal application for new credit, such as a mortgage, auto loan, or credit card. This inquiry indicates you are actively seeking new debt. Each hard inquiry appears on your credit report and can be seen by other lenders.
Impact of Inquiries on Your Credit Score
Hard inquiries typically result in a small, temporary decrease in your credit score, often just a few points. This slight dip reflects the increased risk associated with seeking new credit, as borrowers who apply for multiple new accounts in a short period are more likely to default.
A hard inquiry remains on your credit report for approximately two years. However, its effect on your credit score usually diminishes within a few months. After this initial period, the inquiry’s influence on your score becomes negligible, even while it remains visible.
For certain types of loans, such as mortgages, auto loans, or student loans, credit scoring models recognize that consumers often “rate shop.” To accommodate this, multiple inquiries for the same loan type within a specific timeframe are treated as a single inquiry. This grouping period typically ranges from 14 to 45 days, depending on the scoring model. This allows consumers to compare offers without their score being penalized.
Other Credit Score Factors Related to Loan Applications
Beyond the initial inquiry, the outcome and management of a new loan significantly influence your credit score. If a loan application is approved and a new account opened, it impacts several components of your credit profile.
Opening a new loan account can initially shorten the average length of your credit history, especially with a long-established credit profile. This is because the new account reduces the average age of your open accounts, which can affect the “length of credit history” component of your score. Additionally, “new credit” can be viewed with caution by scoring models, as it represents a recent increase in potential debt obligations.
A new loan can also affect your credit mix, which considers the diversity of your credit accounts. If the new loan introduces a different type of credit, such as an installment loan (like a car loan) when you primarily have revolving credit (like credit cards), it can positively contribute. A balanced mix demonstrates your ability to manage various forms of credit responsibly.
Furthermore, the “amounts owed” category of your credit score can be impacted by a new loan, particularly if it significantly increases your overall debt burden. For revolving credit, this often relates to your credit utilization ratio, which is the amount of credit you are using compared to your total available credit. While installment loans don’t directly factor into credit utilization, the overall increase in outstanding debt can be considered by lenders in their risk assessment.
Consistent and timely payments on any new loan, as well as existing accounts, are crucial. Payment history is the most influential factor in credit scoring models, accounting for approximately 35% of a FICO score. Making payments on time demonstrates financial responsibility and is the most effective way to build and maintain a strong credit score.