Credit Inquiry: What Is It and How Does It Work?

It’s an indisputable — and unfortunate — fact of adult life: Your credit history is a crucial party of your economic well-being. It essentially summarizes your financial past and it’s a critical factor for lenders when they assess your creditworthiness — in other words, how much money you can be trusted with.  

A positive credit history demonstrates you’re dependable when you repay loans and bills, which can lead to more favorable interest rates and higher credit limits on future loans. Conversely, a negative history can limit your access to credit or result in higher interest rates.

Which brings us to a credit inquiry: When a lender or creditor checks your credit through a credit inquiry, it leaves a footprint on your credit report. While a single credit inquiry will only have a minor impact on your credit history, multiple credit inquiries within a short span can indicate potential financial stress or an increased risk of borrowing.

Thus, managing how many credit inquiries you have — and how often you get them — is essential to maintaining a healthy credit profile.

What Is A Credit Inquiry?

When you begin a notable financial transaction — ranging from taking out a mortgage to applying for a credit card — a lender will perform a formal procedure known as a credit inquiry. A credit inquiry is when a lender or potential lender checks your credit, when you check your credit score or request your own annual credit report. Depending on the type of request, credit inquiries may affect your credit score. This report provides the lender with an individual’s credit report and gives insight into their creditworthiness.

The inquiry allows the lender to review your borrowing and repayment history, including details about existing credit accounts, payment history and any outstanding debts. The results of a credit inquiry often influence the lender’s decision regarding approval, interest rates or credit limits.

Hard Credit Inquiry Vs. Soft Credit Inquiry

There are two types of credit inquiries: hard and soft.

A hard credit inquiry occurs when a person applies for credit, such as a loan or credit card, prompting the lender to check their credit history. This type of inquiry can impact the borrower’s credit score and appears on their credit report, which means it is visible to other potential lenders.

A soft inquiry typically occurs when a borrower is undergoing a background check, exploring preapproved credit offers or when individuals check their own credit score. Soft inquiries do not affect credit scores and are generally not visible to other creditors.

Each hard inquiry can slightly lower your credit score, though the effect is often minimal. However, multiple hard inquiries within a brief period can signal increased risk to lenders, potentially resulting in a more significant impact on your credit score. That’s why you should try to manage credit inquiries by minimizing unnecessary applications for credit. This may be a bit different for other types of loans like a mortgage or auto loan. Read the fine print before applying anywhere to understand any stipulations.

How Credit Inquiries Work

When lenders request your credit report, they are essentially looking for a pattern of financial behavior. The more consistent your payment history is, signals to lenders you are a responsible borrower. Lenders may give you better offers on interest rates, terms and loan limits than if you had a more sporadic payment history and credit report. the better the outcome for you (for example, lower interest rates, higher loan ceiling).

Lenders typically look at two different factors in your credit history: your debt-to-income ratio and credit score.

Debt-to-income ratio: Let’s say your income is $5,000 per month. If you have a $1,100 mortgage payment, a $400 car payment, a $500 personal loan payment and $100 worth of minimum credit card payments between different accounts, your total debts are $2,100. When you put those numbers into our formula ($2,100/$5,000 = 0.42), your DTI is 42%.

Although what DTI you will need for qualification will depend on the type of loan you’re getting and the lender, for the purposes of a mortgage, a common recommendation is to maintain a DTI of around 43% or lower in order to qualify for the most possible mortgage options.

Credit score: The other piece of information that lenders get when they pull your credit is your credit score. Although the score can vary depending on which scoring model is being used — FICO^® and VantageScore^® are the most popular — FICO^® does make public the general breakdown of how your score is calculated.

• Payment history (35%): The biggest factor in your credit score is simply whether you make your monthly payments on time in at least the minimum amounts. Late payments hurt your score, while a history of on-time payments will help.
• Debt owed (30%): This element is based on the amount of debt you have. It includes installment payments on monthly debts, but those don’t change much on a monthly basis. What you can change on a monthly basis is your credit utilization, which is the balance you have on your credit cards divided by your combined credit limit between accounts. If you charge $2,000 worth of items per month and have a $10,000 combined credit limit, you have a credit utilization of 20%. The lower this figure is, the better.
• Age of credit (15%): This is based on the age of your oldest active account. The idea here is that the longer you’ve had credit, the more lenders can be confident in the history.
• Credit mix (10%): Lenders want to see a mix of both installment and revolving debts, which will illustrate that you have a history of responsibly handling payments on different types of loans.
• New inquiries (10%): New credit inquiries will temporarily lower your score slightly. The reasoning is that if you take out new credit frequently, lenders can be concerned that you may be overextending yourself. If you’re shopping around for the best rate on a mortgage, auto or student loan, this works a little bit differently – these inquiries are typically seen as one pull if they are made within a short period of time.  

Do Credit Inquiries Affect Your Credit Report?

Credit inquiries do indeed affect your credit report, as they can impact your credit score. When you apply for credit — whether it’s for a loan, a credit card or a mortgage — the lender typically requests access to your credit report to evaluate your creditworthiness. This triggers a credit inquiry, which means someone has accessed your credit report.

But as previously noted, there are two main types of inquiries — hard inquiries and soft inquiries — and they affect your credit differently. Hard inquiries occur when you apply for credit and typically involve a thorough review of your credit report by the lender. These hard inquiries are included in your credit report and are visible to other potential lenders. Soft inquiries, on the other hand, don’t impact your credit score and are often made for informational purposes or background checks.

Both hard and soft inquiries are recorded on your credit report, but only hard inquiries have an impact on your credit score. Hard inquiries can stay on your credit report for up to 2 years, although they generally only affect your credit score for the first year. The presence of multiple hard inquiries within a short period can signal increased risk to creditors and might lower your credit score temporarily, because repeated inquiries could suggest that you’re actively seeking credit, which could lead to financial strain or increased debt.

How To Protect Your Credit Score From Hard Inquiries

Having a high credit score is critical to creating a strong economic foundation. That’s why it’s important to take some steps to safeguard your credit score from the negative impact of numerous hard inquiries. They include:

• Leaving time between credit applications: The reason here is simple: when you apply for multiple lines of credit within a short timeframe, each hard inquiry could temporarily lower your score. If you’re shopping around for rates on a loan rather than credit card, you may be able to have multiple inquiries in a short span of time and have them count as one pull on your credit report. Be sure to read the fine print before applying with any lender.
• Applying for credit only when necessary: When you apply for credit often, it could signal to creditors — rightly or wrongly — that you don’t have a lot of control over your finances. Therefore, apply for credit only when it’s really important.
• Monitoring your credit history: It’s important that you keep a close eye on your credit in order to dispute fraudulent hard inquiries. Erroneous inquiries can negatively influence your credit rating, so be vigilant. There are different types of credit report errors, and they include:
  
  
  • Identity errors, which refer to incorrect information about you specifically. This could include an incorrect name, address or phone number. Identity errors can also be caused by other people's information showing on your credit report, especially if you have a very common name.
  • Balance errors, which mean your overall credit card balance is wrong. Because this information can be used in determining your overall credit score, it's important to ensure that the balance you carry is accurate.
  • Account errors, which include accounts that are reported as delinquent even when they are not, closed accounts still reporting as open, incorrect information regarding payment or delinquency dates, and being reported as an account owner on an authorized user account.
  • Duplication errors, which occur when accounts or balances show up multiple times on your credit report. 

• Keeping your credit card balance low: By not accumulating too much credit card debt, you signal to lenders that you are responsible and can practice sound credit management.
• Paying your bills on time: Late payments can significantly impact your credit score, so consider setting up auto-pay functions for your recurring bills.

The Bottom Line: A Credit Inquiry Is Part of Your Credit History

Understanding what a credit inquiry is, as well as its implications on your credit report, is crucial for safeguarding your financial future. Being aware of credit inquiries can empower you to make more well-informed financial decisions and help you create a healthier credit profile. To help protect your financial future, download the Rocket Money^SM app to continue gaining insights into your financial health.