How Credit Enquiries Affect Your Credit Score
Your business credit score – that innocuous little three-figure number – can significantly shape the future of your company. It will determine not only your access to credit but also the interest rate you pay, so the effect of even a relatively small shift can be significant. But how do credit enquiries shape this magic number?
Why credit enquiries really matter
Every time you apply for a new form of finance, the lender is likely to check your credit score with one or all of the major credit bureaux. This applies equally across business and personal finance, covering car loans, credit cards, mortgages and student loans as well as business loans. The lender will be looking to assess your reliability as a borrower in order to make a decision and set the interest rate.
However, this can have a negative effect on your credit score: 10% of which is based on your new and recent borrowing. Any new credit will be preceded by a credit enquiry, creating a flag on your credit report – which will be impacted again if you actually take out the borrowing. However, this isn’t as simple as it appears, as there are two different types of credit enquiry.
What is a soft credit enquiry?
Soft credit enquiries, as the name suggests, do not affect your credit score. A soft enquiry does not involve a lender evaluating you for potential borrowing: it could involve you checking your own credit score, a potential supplier assessing your creditworthiness, a credit card issuer or lender seeking pre-approval, or an employer screening you before making an offer.
There are also a few grey areas: if you’re looking to rent a car or property, have your identity verified by a financial institution, or open a current or savings account, these enquiries could count as either soft or hard enquiries.
What is a hard credit enquiry?
In contrast, hard credit enquiries will affect your credit score, whether or not you are approved for the finance in question. However, the good news is that the impact isn’t permanent – these enquiries will show on your credit score for a maximum of two years.
Hard enquiries only occur when you are being considered for a new form of finance, and are generally initiated by a bank, card issuer or other financial institution. Applications for loans (whether business, car, student or personal), mortgages or credit cards almost always result in hard credit enquiries. However, this won’t come out of the blue: you need to give your permission before this type of credit enquiry is made.
So what effect do credit enquiries have on your score?
Research by FICO – the company whose algorithm determines your credit score – demonstrates that borrowers who take out several new forms of credit within a short time are likely to be bad risks. This is particularly the case where they do not have a long credit history. For example, a borrower with six recent hard credit enquiries is eight times more likely to go bankrupt than a borrower with none. In short, applying for lots of loans simultaneously strongly implies that you are desperate for cash, significantly reducing your likelihood of being accepted for any of them.
That said, one or two hard credit enquiries won’t do any serious damage to your score – FICO know that everybody needs to borrow from time to time. In fact, the maximum impact on your score would be five points, which is pretty insignificant. However, when a larger number of hard enquiries are made in a short time, the impact could be substantial.
The situation is complicated by the fact that FICO does not weight all credit enquiries equally. If it looks like you’re shopping around for the best interest rate and are likely to accept only one offer, this isn’t likely to be a huge problem. For this reason, multiple enquiries for the same type of credit within a 30-day period are known as “rate shopping” and are largely disregarded.
Your previous behaviour as a borrower will also be taken into account, so if you have a long and responsible credit history FICO won’t be alarmed by a number of hard enquiries. However, if you don’t have much history of borrowing (or a history of failing to repay on time and in full) a flurry of hard enquiries will be seen as a huge red flag.
Do hard credit enquiries always affect your score for two years?
By no means – this is the absolute maximum. And whilst the enquiry can remain on your report for two years, it will only affect your actual score for a maximum of one, with six months being far more common. In some cases, the effect on your score may be minimal or even zero, particularly if you have an excellent history as a borrower. Ultimately, your history and credit utilisation (the amount you’ve borrowed compared to your credit limits) will be far more important, so the odd hard credit enquiry should not worry you at all.
Can credit enquiries be removed?
As already indicated, hard credit enquiries can only take place with your express permission. Therefore, should an unauthorised hard credit check occur, you can dispute this section of your report. First, you need to monitor your credit score and look at your report and see which lender made the unauthorised enquiry. You can then call the lender and ascertain why the enquiry was made, as well as obtaining more details from the credit bureau. By liaising with both companies, you should be able to ensure that the unauthorised enquiry is quickly removed from your report. Should this not happen, you are at liberty to file an official dispute with the credit bureau.
A few credit enquiries won’t hurt you
Don’t be afraid of applying for new credit if you need it or doing a little “rate shopping” – it isn’t going to cause any long-term harm to your credit score. It’s also important to understand when to mix your personal and business credit and being able to balance the risk and reward. Simply avoid taking out multiple forms of finance simultaneously, try to limit your hard credit enquiries to one or two per year unless you’re “rate shopping” – and concentrate on being a responsible and reliable borrower.
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