How does shopping for a loan affect your credit?

If you’re in the market for a new home or car, you can benefit financially from shopping around among a number of lenders for the lowest interest rate. However, according to Ovation, if you’ve heard that multiple credit checks can negatively affect your credit score, you may be hesitant to approach more than one lender. Below is a quick review of what you need to know in order to enjoy peace of mind and get the best possible deal on your loan.

The credit rating agencies support the idea of consumers shopping around for a good loan. They understand that prudent money management includes gathering information from a range of lenders and then making an informed decision. However, the credit bureaus also want to be able to distinguish between a person planning to make a single major purchase and one who habitually tries to borrow money in order to make ends meet. The way they distinguish between these two types of borrowers is to check the calendar. If you approach a half dozen lenders for an auto loan within a short period of time, and each of them requests a credit score for you, the credit rating agencies will generally count it as one single inquiry. However, if you have a persistent habit of applying for loans scattered over many months, it will reflect poorly on your credit score.

So how long exactly is that permissible shopping period? Unfortunately, the answer is slightly vague, because the credit scoring companies aren’t primarily in the business of providing information to consumers. When you approach a lender and apply for any kind of credit, that lender requests a credit score from a scoring company — usually FICO. The lender’s inquiry is entered on your credit report, where it will stay for two years. If you are well-organized and do all your loan shopping within a two-week period, then all the inquiries that come in will only be counted as a single inquiry. If you take a month to apply to different lenders, those multiple inquiries will probably still only count as one — but it depends on which type of FICO scoring formula is used. Older FICO scores limited the shopping window to two weeks, but newer ones allow up to 45 days. Many financial advisers advise a one-month limit on your shopping period, and Experian simply suggests “a short period of time.” Each credit inquiry (or batch of inquiries within a single time window) will shave about five points off your credit score.

If you happen to have a busy month during which you simultaneously apply for mortgage loans and auto loans, your credit score will show two inquiries: One for the mortgage loans you applied for, and the other for the auto loans.

The time period mentioned above applies to school loans, auto loans, mortgages or bank loans for miscellaneous purposes. Credit card applications, however, are treated differently by the credit scoring companies. There is no permissible “shopping window” for applying for various credit cards, and multiple credit card applications will inevitably damage your credit score.

At this point, you may be wondering how safe it is for you to check your own credit score. This is a good time to identify the difference between soft and hard credit requests. So-called “soft” credit requests include you asking to see your own credit score, or a landlord or employer checking your credit to see how reliable a person you are. Additionally, any promotional credit card offer you receive in the mail has probably done a soft credit check, but you are not accountable for these marketing campaigns. Soft inquiries don’t get recorded on your credit report, and they have no effect on your score. “Hard” inquiries are the ones made by lenders, when you initiate an application for credit, and they are the type of inquiry that shows up on your credit report. There are some ambiguous situations such as signing up for internet or phone service, renting a car or opening an investment account, which can trigger hard or soft credit requests. The only way to know is to ask the creditor.

The process of purchasing a home or car often takes longer than two weeks or a month, and it’s important to keep the whole inquiry-credit score issue in perspective. If it’s been two months since you first applied for an auto loan, but you happen to find a dealer or a bank that’s offering a great interest rate for exactly the car you want, it makes sense to go ahead and apply for the loan. Losing another five points off your credit score isn’t going to make much difference in the long run, whereas getting a loan with a stellar interest rate can save you thousands of dollars in cold hard cash.

The process of credit scoring can feel mysterious, especially since it goes on behind the scenes and involves numerous variables. Even though you don’t have access to the precise proprietary scoring formulas, it’s helpful to gain a general overview of how they are calculated. Armed with this information, you can make a better decision about how to time your loan applications.