Credit scoring is a huge part of the mortgage world.
A given credit score can mean the difference between a 5 percent rate and a 6 percent rate; a conventional mortgage and an FHA mortgage; an underwriting approval and an underwriting denial.
And yet, there's a persistent belief among Americans that "having your credit checked" is a bad thing.
In some instances, yes. In most instances, though, no.
See, not all credit applications are created equal. At least, not in the eyes of the bureaus.
A formal credit pull by a mortgage company is treated differently from applying to get 10% off at Target. To understand why, let's start with some credit scoring basics.
Credit Inquiries Are A Formal ProcessA "credit inquiry" is a formal request to review a person's credit report.
Credit inquires are grouped with other traits into a credit-scoring category called "New Credit". New Credit represents 10 percent of a person's complete credit score. On the
scale of 300-850, therefore, credit inquiries represent a tiny portion of a maximum of 85 points to a FICO.
There are many times of credit inquiries, but really only 4 of the set can impact a person's credit score:
1. A credit check for a mortgage loan
2. A credit check for an auto loan
3. A credit check for a credit card application
4. A credit check for a store credit card, or consumer loan
These 4 types are singled out because, in each case, the inquiry is made by the applicant in order to get access to more debt. Because extra debt increases the probability of default, credit inquiries can sometimes foreshadow trouble.
Even then, however, the risk of default varies by application type.
For example, credit card applications can be more damaging to a credit score than a mortgage application. This is because credit card debts tend to revolve higher over time versus a mortgage which eventually pays down to $0.
So, all things equal, a credit card application will harm your credit score more than an application for a home loan.
A Credit Inquiry Lowers Your FICO By 5 PointsWhen compared to the other credit scoring elements, Credit Inquiries is a relative nothing.
In the official FICO scoring model, Payment History and Credit Utilization account for 65% of a score, combined, and the amount of time during which you've had credit to your name accounts for 15%. These three areas are over-weighted because the bureaus are more concerned with what you've already
done with your credit versus what you might do with
more of it.
Your credit past is the best clue to your credit future and it's one of two reasons why it's okay to give your social security number to as many lenders as you want. The impact of a credit inquiry is tiny next to the value of being a Model Credit Citizen.
A mortgage credit inquiry is estimated to lower a credit score by just
5 points.
Unfortunately, we'll never know for sure because the very act of examining the credit score causes it to move. In Physics, this is called the
Heisenberg Principle. On MTV, it's called The Jersey Shore Syndrome. Put a camera on something, and it changes.
The Credit Bureaus Don't Hit Your FICO TwiceThe second reason you should shop around with lenders is that -- unlike applying for multiple credit cards -- applying for multiple mortgages won't count as multiple, consumer-initiated inquiries. This is a common thing.
You might apply for 5 credit cards and use them all. You're not going to be approved for 5 mortgages.
As such, the credit bureaus have
made it a formal policy to permit "rate shopping". Talk to as many lenders as you want in a 14-day time frame; have your credit checked as often as you'd like; compare rates and fees. All of the inquiries will be lumped into a single application.
It's good for you and it's good for the bureaus. Your credit scores stay high and TransUnion, Equifax and Experian collect more fees from the banks.
Advice From The Credit Bureaus On Getting Low RatesTo promote rate shopping and to lessen The Fear of Credit Inquiry, the people behind the FICO brand spell out for you the best way to get the best mortgage rates possible:
1. If you want the best rate, you should "shop around"
2. Limit rate shopping to 14-day timespan to keep your credit scores high
3. Mortgage lenders can't give accurate rate quotes without a credit score so give up your social security number
Metaphorically, not letting your lender see your FICO is like not letting your doctor check your blood pressure. You'll get a diagnosis when the appointment is over -- it just might not be the right one.
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John Payne is an active Mortgage Planner. Email John@JPMortgageLoans.com or call 510-799-1400 or 800-259-3424.
