How can shopping loan rates affect your credit?

4 min read
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If you’re planning to take on a new loan — whether by buying a car, a home or using a personal loan to speed up debt payoff — one of the most important factors is the interest rate.

For a long-term loan, committing to a high interest rate could mean thousands of extra dollars in payments over the lifetime of the loan. Even tenths of a percentage point can make a huge difference on substantial loans. That’s why it’s important to find a lender that will offer you both the best terms and the best rate on your interest obligation.

To make sure you’re getting the best deal, shop around for the best rates on certain types of loans before you commit to any single one. But there are a few things you should know before getting started:

What is rate-shopping?

When you apply for large loans like mortgages or auto loans, it’s common to apply for more than one in order to see which will result in the most favorable rate. However, each time you apply for a loan, a hard inquiry is made on your credit report. This gives your potential lenders a comprehensive view of your borrowing history and allows them to decide whether you’re responsible enough to take on the risk according to their criteria. But it also has the potential to bring your score down, at least temporarily.

Since creditors understand that applying for several large loans of this sort at once doesn’t mean that you actually want to take out multiple mortgages or buy multiple cars within a short time, loan applications for the same types of loans submitted within a given time period only results in one single hard inquiry on your report.

For instance, if you apply for mortgages with three different lenders within the given timeframe, that will only count as one hard inquiry. If you apply for a mortgage with three lenders and also apply for a car loan within that same period, though, you’ll see two inquiries on your report.

What is the time frame?

Each lender may use a different credit scoring model when evaluating your application, and each of those models have a different rate-shopping window.

Generally, this window can range anywhere from 14 to 45 days. If you’re not sure which scoring model your potential lenders may use, though, make sure you submit each of your applications within a 14-day period to be on the safe side.

You also won’t see the effects immediately; the hard inquiry will appear on your report 30 days after it’s made. According to FICO, only inquiries from the past 12 months are considered in your credit score, but an inquiry remains on your credit report for two years.

Rate-shopping doesn’t work for credit card applications

While shopping for a great rate on your mortgage is a well-known practice for potential homebuyers, creditors don’t look as favorably upon those who apply for multiple credit cards within a short amount of time. Too many credit applications within too-short a time span can make you look like a risky borrower, not a savvy lendee.

Instead, look for a card that offers a lower range of APRs, if you plan on carrying a balance. But with average interest rates currently hovering above 17 percent, it’s smarter to pay off your balances each month and instead look for a card that suits your spending habits.

After you’re approved

Taking out a new loan, no matter what type, affects your credit score in another way, too.

Once you undergo the underwriting process for your mortgage or activate your new credit card, the new account will appear on your credit report and impact another factor: average age of accounts.

“In both FICO and VantageScore’s credit scoring systems, the effect of the inquiry is the least important of all of the scorable metrics,” says John Ulzheimer, credit expert, formerly of FICO and Equifax. “The one right above it is the average age of your accounts.”

If you add a new account or multiple new accounts to your credit report, then the average age of your accounts will inevitably shorten. “That, actually, can have a much bigger impact on your credit score than a remote inquiry that may or may not be appearing on all of your credit reports,” Ulzheimer says.

Still, this shouldn’t stop you from taking out a loan. Continue making consistent, timely payments towards the loan over time and refrain from taking on multiple new accounts within a short amount of time. Other factors, like payment history and credit utilization ratio, still account for higher percentages of your overall score and can help you keep a healthy score.

Prepare your credit in advance

Before taking out a large loan, take time to evaluate your financial health as a whole. Are you prepared to take on a large loan? Do you have a plan to pay it off over time? What effects may this new debt have on your day-to-day budget?

“Knowing how much you make, and how much you usually spend, will give you a good idea for what you can afford in terms of this new payment,” says Scott Newhouse, financial planner and founder of Forthright Finances in Thousand Oaks, California. “And given that these payments go on for years, it’s even more essential to know that you aren’t spending beyond your means.”

If you’re taking out a loan that has long-term consequences, like a mortgage, you should also ensure your credit is in top form and not apply for a new credit card or buy a car within a few months of applying for the loan. You’ll want the best rate possible on a loan that you’ll carry for the next few decades, and shouldn’t risk it for these shorter-term commitments.

Practice good credit habits to ensure your credit score is healthy: make timely payments in full each month on each of your open accounts, maintain a credit utilization at or below 10 percent and keep from applying for several accounts at once.

Ultimately, though, a single hard inquiry will have negligible, if any, effect on your credit. Any effect it may have is temporary and shouldn’t be concerning if you’re starting out with a great credit score anyway.

“While inquiries can have a negative affect on your credit, I wouldn’t sweat them too much,” Newhouse says. “Don’t get inquiries needlessly, but don’t overly fret if you have to do an inquiry.”