This is the last of a five part series investigating credit scores and how your credit-related actions most influence them. Each edition of the series explored a new category chosen because of the amount of credit score points that each could cost you if not managed properly. So far we’ve explored the following four…

1. Your Payment History – Worth 35% of the points in your credit score. The most important category.

2. Your Amount Of Debt – Worth 30% of the points in your credit score. Surprising to some that your debt is almost as important as payment history.

3. The Type of Accounts In Your Credit Reports – Worth 10% of the points in your credit score. A healthy mix means more points.

4. How Long You Have Had Credit – Worth 15% of the points in your credit score. The older your history to better your score.

Collectively these four account for 90% of the points in your credit scores. Without solid performance in each of these areas it would be impossible to earn a score high enough to qualify for credit at the best interest rates and terms.

The last of the five categories is Your History of Searching for Credit. This category is worth the final 10% of the points in your credit score. So why is this one important and why did it get saved for last? The reason is that this category includes measurements taken from perhaps the most misunderstood part of your credit reports…Inquiries.

“Inquiries” is the fancy name for the section of your credit report that keeps record of who pulled your credit report, when and for what purpose. Any time anyone pulls your credit report federal law requires that each of the three credit reporting agencies keep a record of that activity for up to 24 months. This record is commonly referred to in the lending industry as an “ inquiry for credit.” Every time you apply for a loan, pre-qualify for a mortgage, fill out a credit card application or ask for a copy of your own report an inquiry is posted to your record.

There are many different types of inquires because people will look at your credit report for many different reasons. We will categorize them all into two categories:

Hard Inquiries and Soft Inquiries

Hard Inquiries – The term “hard inquiry” is an industry term used by creditors. It means that you’ve applied for credit from some sort of lender. A hard inquiry will show up on your credit report when you do any of the following…

• Apply for a car loan
• Apply for a student loan
• Pre-qualify or apply for a mortgage or other home-related loans such as a home equity loan
• Fill out and return any of the many “pre-approved” offers of credit that you get in the mail
• Take advantage of “instant credit” offers when you are at the shopping malls
• Apply for a store credit card from electronics retailers
• Apply for credit from any lender using the Internet

The common theme amongst all of these examples is, quite frankly, you. You have made the conscious decision to apply for something from someone who has offered you the benefit of credit. This act is captured, recorded and displayed on your credit reports as a hard inquiry. These inquiries will show up on your credit reports for two years. Any company who pulls your credit reports will be able to see the entire list of hard inquiries. Credit scoring models will also see them. They are fair game.

Soft Inquiries – Again, this is an industry term used by creditors. Soft inquiries are a record of when someone pulls your credit reports for a reason other than making a decision on your credit applications. Soft inquiries will show up when any of the following occurs…

• A lender has purchased your name from the credit bureaus for the purposes of sending you some sort of credit solicitation in the mail.
• A lender with whom you already have credit reviews your credit report.
• One of your credit card companies wants to re-issue your credit card before the expiration date.
• You have asked for a copy of your own credit reports, either directly from the credit bureaus or through one of the various online services that resell credit reports.

The common theme amongst these examples is that you did NOT proactively apply for any type of credit. These are all examples of when someone accessed your reports for a reason other than approving a credit application. These inquiries will show up on your credit reports for six months. Further, they are not displayed to any lenders who pull your credit reports. They are also not counted in any credit scoring models. Only you have access to see the list of soft inquires on your credit report. They are off limits to everyone else.

Sometimes these inquiries are called “promotional” or “account review” inquiries. This is an effort to differentiate them from their less consumer friendly brethren, hard inquires.

Why do inquiries matter?

As with anything that makes it into your credit score calculation, a strong statistical correlation to your risk as a borrower is required.

Inquiries matter because they are the only way anyone knows if you are actively shopping for credit. They are also the way to measure if you are excessively shopping or not. If it weren’t for inquiries it would be impossible to know if and when you are credit shopping.

In fact, it is a proven fact that consumers who are actively looking for credit or have excessively shopped for credit in the past 12 months are a higher credit risk than consumers who have not.

But how can I get credit if I don’t shop for credit?

The simple answer is that you can’t. It’s impossible. Anytime you want to shop for a loan or apply for a credit card the lender is going to want to look at your credit reports and credit scores. When they do so it will post a hard inquiry, which can lower your credit scores.

And, when you want to shop around for the best loan rate you could end up with multiple inquiries from multiple lenders. This is very common especially in the mortgage and auto lending environments. Generally consumers will shop around for the best mortgage and auto loan interest rates.

How do credit reports and credit scores treat the act of shopping around for the best interest rate?

In order to address this question you have to split them up and examine changes in consumer credit shopping patterns over the past 20 years.

Credit Reports – Here’s the bad news. Credit reports are nothing more than warehouses that store your credit histories. They don’t have a brain so they cannot distinguish between when someone is shopping for the best interest rate versus someone excessively shopping for credit. The two actually look very similar on a credit report. A lot of inquiries may be posted in a very short period of time and there’s no difference on the surface.

Credit Scores – Here’s the good news. Credit scores are actually quite sophisticated and can be programmed to interpret credit data, specifically inquires, in an appropriate way. . A smart credit scoring model will be programmed to read multiple inquiries in a short period of time as a consumer shopping around for a good deal on a car or mortgage loan and not a consumer applying for four or five separate loans.

A Little History – Here’s the bottom line. Think about how the credit landscape has changed in the past two decades. Twenty years ago the widespread access to lenders via the Internet was a fantasy. Consumers certainly didn’t shop around as aggressively as they do today. Think about it. You can actually apply for almost any loan at any time of the day or night right from the comfort of your own home and get an answer virtually immediately.

If the companies that developed credit scoring models wanted to treat consumers fairly they would be forced to adjust how their models treat the act of shopping for a loan. To their credit, they did exactly that.

It’s 1985 - Shawn wants to apply for a mortgage. He goes to his local bank or credit union and meets with the same person whom he’s borrowed from for years. He fills out paperwork and two months later he gets a decision as to whether or not he has been approved and at what interest rate. This process resulted in 1 inquiry being posted on his report.

It’s 2005 – Shawn wants to apply for a mortgage. He logs on to the Internet and goes to several bank and mortgage company websites where he applies to “pre-qualify” for a mortgage loan. In about two hours he has guaranteed interest rate quotes from a half dozen lenders who are willing to overnight him paperwork to get his loan process started. This process resulted in six inquiries being posted on his reports.

Would it be fair to treat those inquiries the same way when they happened 20 years apart? Of course it wouldn’t. Shawn is still only going to have 1 loan regardless of how many inquires are on his credit reports. As such, the credit scoring industry had to change how they treated inquires to keep up with changes in how consumers shopped for credit.

Here’s what the industry did. They incorporated a process called “Inquiry De-duplication” into their scoring models. In English this means that they built a way to treat multiple inquires resulting from the act of shopping for one loan as one inquiry. The logic was actually quite simple and makes very good common sense. How can you tell if someone is shopping for a car loan or a mortgage? It’s very likely that all of the inquiries would be from auto lending companies or mortgage lenders, correct? It is also very likely that these inquiries would occur over a short period of time because consumers tend to shop for those items over a short timeframe.

Fair Isaac, the developer of the FICO credit score, uses a 14 day window for their de-duplication. Any inquiries that can be reasonably assumed to be from a car loan or mortgage application that occur in a 14 day window are treated as one inquiry in their scoring models. It doesn’t matter if you have 20 inquires. As long as they are from lenders who can grant auto or home loans AND they are all done in a 14 day period they only count as one. In fact, this logic is in the process of being expanded to count the same multiple inquiries occurring within a 45 day period as 1 inquiry.

This de-dupe logic allows consumers to shop around for the best interest rate without having to worry about inquiries lowering their scores. It also removes any barriers preventing consumers from applying at many creditors, which is good for credit report and credit score sales. Certainly a smart move for the respective businesses since credit reporting agencies and credit score developers are paid each time a credit report and credit score is pulled by a lender.

How do you know if you have too many inquiries?

It’s the million-dollar question. How many inquires is too many?

There are two ways to tell if you have too many inquiries.

Score Factors – Each of your credit scores is accompanied by reasons why your score wasn’t higher. These are called “Score Factor Codes” or “Reason Codes.” There are generally four of these plain English explanations delivered with each score. If one of these four explanations is “You have too many inquiries” then you can be sure that your inquiries are hurting your credit score.

FACTA – FACTA is the acronym for the Fair and Accurate Credit Transactions Act. This act amended the Fair Credit Reporting Act in many ways. One of those ways is relevant to inquiries and their impact to your credit score. Even if your inquiries played a minor role in lowering your score you still have the right to know that. The following language is now a matter of federal law:

“If a key factor that adversely affects the credit score of a consumer consists of the number of enquiries (sic) made with respect to a consumer report, that factor shall be included in the disclosure.”

If you apply for a mortgage then you will receive your credit reports, credit scores and all factors that adversely impacted those scores, including any impact of inquiries. This portion of FACTA is specific to the mortgage environment. So, don’t expect your credit card issuers or your auto dealer to share this information with you.

Ideally you want to have the fewest number of inquires. Here’s why:

The Impact to Your Credit Scores

Credit scores are a standard component used in today’s lending environment. Each of us has three different credit scores, one generated from each of our three credit reports from the three credit reporting agencies. It’s important to become familiar with the impact that inquiries has on your credit scores.

Since your scores go down as your number of inquires goes up it’s important to only apply for credit when you need it and not as a leisurely act.

How can you ensure earning the maximum points available out of the Your History of Searching For Credit category?

Here are some simple steps you can take to ensure earning the most points out of this category:

1. Avoid the temptation of taking advantage of discounts in exchange for applying for a credit card. This is the number one culprit and it absolutely kills your ability to earn maximum points from this category. During the year-end holiday season, mall retailers are in hot pursuit of new customers and one of their tactics is to offer shoppers a discount of roughly 10% off their first purchase if they will agree to apply for a store credit card. This may sound like a good way to save a few bucks but it’s a terrible idea. Here’s why:

• John wants to buy $150 of gifts at a store at the mall and the clerk offers him 10% off his purchase if he’ll apply for a store credit card. The $15 discount sounds great to John so he takes advantage of the offer. His actions have resulted in one new inquiry.
• John continues his holiday shopping over the next few days and takes advantage of a few more offers in order to save another $100. His actions have resulted in three or four more new inquiries.
• Three months later John wants to apply for a car loan but he discovers that the inquiries have dropped his credit score below where they need to be to qualify for the lender’s best interest rate. As such, the payment on his auto loan is $75 higher each month or $3,600 over the term of a 48 month loan. The $115 dollars he saved shopping for holiday gifts has just cost him $3,600 in additional interest payments.
• Six months later John wants to buy a new home (or refinance his current home loan) to take advantage of low interest rates. However, he discovers that, because of his number of inquiries over the last six months, his credit scores are still below where they need to be to qualify for the best mortgage interest rate. As such, his monthly mortgage payment is $150 higher each month or $54,000 over the term of a typical 30-year mortgage loan. Now John’s $115 savings will cost him almost $60,000 in the long run. Certainly a poor decision to use his credit reports as a 10% off coupon at the mall.

This may seem like a far-fetched example but it isn’t. In fact, it could be much worse. In some cases it would only take one new credit inquiry to lower your scores enough that you don’t get the best interest rates.

Further, consumers who open new credit cards at the mall during the holiday season will tend to do so during the remainder of the year as well. Sporting events are another hot spot for these “apply for a credit card in exchange for a free gift” promotions. Except in this case you’re lowering your credit scores in exchange for a t-shirt or a coffee mug instead of 10% off.

2. Do your home loan or auto loan shopping within 14 days. Take advantage of the de-dupe process described earlier in this newsletter. By doing so you will minimize the impact inquiries have on your credit scores.

3. Do not let auto dealers pull your credit reports without your permission. If you are not familiar with a process called “shotgunning” you should be, especially if you are in the market for a new car. Shotgunning is a process where car dealers shop your potential auto loan out to multiple lenders while you take your test drive (ever wonder why they ask for a copy of your drivers license?) The problem with this process is that a) it’s illegal and b) it will result in numerous inquires on your credit report. Even though they have all occurred within a 14 day period you will not want anyone, especially a car dealer, to have access to your credit reports until you give them permission to do so.

4. Have unauthorized inquires removed from your credit reports. It’s unfortunate but there are tens of thousands of examples of consumers being penalized because someone pulled their credit reports, thus posting inquiries, without their permission. In many cases this can be a warning that you may have been a victim of identity theft. Regardless, if you did not apply for credit then you should not be burdened and penalized by unauthorized inquires. Contact the credit reporting agencies and ask that they be removed. If they refuse to remove them then escalate your dispute by contact their Consumer Affairs group or their Legal Departments.