Most people find it difficult to make large purchases, such as a car or a house, without needing to take out a loan. Financing options and lines of credit, however, come at a cost. You must pay interest on the money you borrow, and those dollars add up quickly.
While it’s financially responsible to look for the best interest rate on these big loans, many consumers are afraid that shopping around will negatively impact their credit score. To get to the truth of the matter, the Open Door Coalition spoke with Amy Thomann, Head of Consumer Credit Education at TransUnion, and nationally recognized credit expert John Ulzheimer.
Your credit score is calculated based on the information found in your credit report, and is used by lenders to assess how much risk they are taking on by offering you credit, said Ulzheimer.
“Credit scores are used to predict the likelihood that someone is going to pay 90 days late or later in the subsequent 24 months,” he explained. “And your score largely determines how much you’re going to pay in interest over the life of your usage of credit.”
For instance, someone with a poor credit history will likely be required to make a larger down payment or pay higher interest rates than someone with a good or excellent credit score.
When a lender checks your credit to determine what interest rate to offer you, it results in a hard inquiry on your credit report, Thomann explained.
“A hard inquiry will stay on your credit report for two years and can be seen by any lender who pulls your report. How a hard inquiry affects a credit score will vary, but your score may decrease for a time after one is placed on your credit report,” she said.
While hard inquiries will show up on your credit report for two years, Ulzheimer said not to worry too much. “Scoring systems are programmed to ignore hard inquiries that are older than 12 months,” so any negative impact of a hard inquiry to your credit score will be temporary.
In order to get the best interest rate available, you need to have several different lenders run your credit so you can see what your options are. But won’t multiple hard inquiries lower your credit score? Not necessarily, said Thomann.
“If you’re shopping around for the best rate and multiple companies place hard inquiries on your credit report, that doesn’t mean your score will necessarily take a big drop. Many credit scoring models count several inquiries in a short time frame as just one inquiry because they know you’re looking for your best credit option,” she said.
“Credit scoring systems have been programmed to differentiate between someone who is shopping around for the best deal on a mortgage or auto loan and someone who is trying to open up a bunch of credit cards at the mall,” echoed Ulzheimer. “Both of the commonly used score brands, FICO and VantageScore, are coded in such a way that they can identify the type of inquiry resulting from a credit pull. So, it's not hard to identify mortgage, auto, credit card and other inquiry types. This is what allows them to build tolerances that allow for rate shopping.”
Before you accept any offer, be sure to read the fine print and understand all the conditions, Thomann advised. Just because one company gives you a great interest rate, that doesn’t mean it is the best option for you. You’ll also want to consider any down payment requirements, extra fees and payment schedules before deciding which lender makes sense for your situation.
Remember, you can't control how an inquiry impacts your credit score, so it’s best to apply for credit sparingly — but don’t be afraid to shop around to find a financing option that works for you.