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Credit Check for Personal Loans: How Does it Affect Your Credit Score?

| Money Rates Columnist
min read

credit-score-meterA credit check for personal loans can lower your credit score. But not by much if you shop for the best personal loans the right way.

  • Each inquiry lowers your FICO score by about three to five points
  • Some scoring systems count all inquiries within 14 days as a single inquiry
  • The potential benefit of shopping for a better personal loan rate should more than offset the small temporary drop in your credit score

While most scoring models count mortgage and auto financing inquiries as one, only the Vantage score gives personal loan inquiries the same treatment as of this writing. So don't let anyone pull your credit score until you decide to apply.

See today's personal loan interest rates

Personal Loan Credit Checks Are Important

A personal loan is unsecured financing, which means you don't have to put up collateral. "Collateral" means an asset that you pledge so the lender can take it if you don't pay your loan. It can be a car, house or other asset. Loans with collateral are safer for lenders because you're more likely to pay your loan to keep your property.

But most personal loans are not secured by collateral. In fact, the only security the lender has is your promise to repay the loan. And your credit score is a pretty good predictor of how likely you are to keep that promise. So if you want a personal loan, expect to allow your lender to pull your credit report and check your score.

Check Your Credit Before the Lender Does

When shopping for a personal loan, you don't have to (and you probably shouldn't) let every lender pull your credit. That WOULD do damage to your FICO score. But you don't have to let anyone pull your credit just to quote you an interest rate.

Check your history yourself, which doesn't harm your score in any way. The good news is that checking credit reports is quick, easy, and free. You have the right to get one no-cost copy of your credit report every 12 months. You can get a report from Experian, TransUnion, and Equifax, the three big credit reporting agencies. Just go to AnnualCreditReport.com and in about two minutes your report will show up.

Look for factual errors, not only with individual accounts but also with the report's general information. If you're Bill Jones and the report is for Billy Jones it's possible that it might include someone else's information.

Another item to check is age. Generally, items more than seven years old are not reported. Exceptions include such things as Chapter 7 bankruptcies (10 years), closed accounts in good standing (10 years), judgments (more than 7 years in some states), unpaid tax liens (in some cases forever), and credit inquiries (2 years).

For a small fee, you can get your FICO scores too. Provide this information to lenders when comparison shopping, and don't authorize an inquiry until you're serious about applying.

How Much Do Credit Inquiries Drop Your FICO Score?

Personal loan providers check your credit as part of their underwriting process. But how does a credit check for personal loans affect your credit score? Especially if you shop for the best interest rate with multiple lenders?

There are two types of credit inquiries, soft and hard. A "soft" inquiry does not impact your credit score. For instance, if you check your own credit report for errors that's fine; your score will not be affected. Other examples of soft inquiries are pulls by companies you already do business with, like a credit card company that wants to offer you a higher limit or additional card.

A "hard" credit inquiry may lower your credit score by about five points. A hard credit pull takes place when you apply for credit. This is a temporary reduction and goes away. The problem is that in the short term, creditors might see a lower score and adjust their rates higher as a result.

Why do credit scores go down when borrowers apply for loans and other forms of credit? The answer is that a hard credit inquiry might signal new debt not yet posted on credit reports.

Multiple Inquiries When Shopping for Personal Loans

It's always a good idea to shop for the best rates and terms when you borrow. However, it hardly seems fair for credit scoring models to drop your credit score for doing the smart thing by shopping around.

The problem is that some shopping is just comparison behavior - few people mortgage several homes at once or buy a fleet of cars. So it's pretty obvious that multiple inquiries for mortgages or auto loans in a short time period are really for one loan.

The credit industry has created a way to resolve the problem of multiple dings for multiple credit inquiries. If you're shopping for mortgages, auto financing, or student loans over a short period then hard inquiries for the same type of loan are combined into a single inquiry. A "short period" is 14 to 45 days, depending on which credit scoring system is used.

Red Flags From Multiple Inquiries

The problem is the other reason people might be shopping for new credit is that they are in financial trouble and want to acquire as much credit as possible before their bills get ahead of them. We all know at least one person who pays one credit card by using another. Or spends more than he or she earns, month after month. Balance creep higher and higher until debt settlement or bankruptcy becomes the only choice.

Credit scoring models are designed to catch these patterns, as multiple inquiries for some kinds of debt are red flag parades.

As of this writing, personal loan inquiries are treated like those for credit cards. The only system that doesn't penalize those multiple inquiries is the VantageScore if you do your shopping within 14 days.

Protecting Your Credit Score

The best way to protect your credit score when shopping for ANY kind of credit is to check your own credit and know your own score (within a range, because there are many FICO scoring models) and provide that when asking for interest rates and loan terms. Only provide your social security number and authorize a report when you are committed to applying with that lender.

While inquiries drop your score only temporarily, they do stay n your report for a year.

What About Personal Loans With "No Credit Check?"

They sure sound enticing. Step right up and get your financing with no credit check!

Let's be real. If YOU were in the lending business would you give money to someone without knowing their credit history? And if you did make such a loan wouldn't it entail a lot of risk? Wouldn't you want a really high interest rate?

When you see loan offers that do not require a credit check, be careful. They are not really unsecured or personal loans. Instead, they are:

  • Auto title loans (secured by your car and rates can run over 100%)
  • Payday loans (fees often average over $50 every 14 days)
  • Check advance loans (An online search found one such loan with a 3600% interest rate!)

Personal Loan Interest Rates: It Still Pays to Shop Around

So, yes, it's true that a credit inquiry can impact your credit score. However, a credit inquiry is likely to do very little damage to your credit standing. It won't impact your credit score for long. The more important point is that shopping for a loan is the best way to get a lower rate and smaller payments. That's your goal as a borrower - and that's why MoneyRates is here to help you find the quotes you need.

See today's personal loan interest rates

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