How Rate Shopping Can Impact Your Credit Score

What is interest rate shopping?

Instead of settling for an offer from one lender, you’re free to shop for your own loan for a major purchase. This can help you feel prepared and confident before going to a car dealership or starting the home buying process. You can start with a search online or by contacting your preferred banks or credit unions for current interest rates and loan terms based on your credit score and financial information. From there, you can move on to the prequalification or preapproval process.

Prequalification vs. preapproval

Typically, the prequalification process is when a lender looks a basic overview of your credit score and finances to determine how much they may be willing to lend you for your potential car or home. You usually don’t have to provide any documents since it’s more of an estimate of what you can expect from a loan offer. To be preapproved, it tends to be a more rigorous process as you may have to provide documentation, like pay stubs, tax returns and other financial information.

With both a prequalification and preapproval, you’ll receive a letter that includes an offer of a specific loan amount. Neither a prequalification nor preapproval is a guarantee that the loan will be granted. Though a preapproval, being much more stringent, can give a more precise idea of how much money you’ll be able to borrow.

How does interest rate shopping impact credit scores?

When you’re rate shopping, you should be mindful of the number of hard inquiries on your credit report. Hard inquiries happen when lenders access your credit report so they can make a decision about whether to give you credit. When you apply for a mortgage or car loan, lenders will make a hard pull of your credit report. These hard inquiries will often lower your credit score. Hard inquiries tend to be one of the least impactful credit score factors and the impact of hard inquiries on credit scores will lessen over time. But if you’re actively seeking credit, it’s important to know there could be a slightly negative effect on your score.

For prequalification offers, whether the application requires a hard or soft inquiry depends on the lender. If you’re not sure whether your prequalification application will result in a hard inquiry, you can contact the lender to confirm. Typically, preapproval offers do require a hard pull of your credit report. To minimize the impact of hard inquiries, try to do most of your mortgage and auto loan shopping in a short time.

Rate shopping time frame

It’s a good idea to bunch your loan applications because of how loan rate shopping is treated by two frequently used credit scoring models, VantageScore® and FICO®. VantageScore counts all inquiries made within a 14-day period as just one inquiry on your credit report if they’re all for one specific type of loan, like a mortgage or auto loan. FICO treats multiple inquiries in a similar way, but you’d need to do it within 45 days for it to count as only one inquiry.

By limiting your loan applications to a short window, you can reduce the negative impact to your credit score. You might want to consider doing all your rate shopping within 14 days to limit the impact no matter which scoring models your lenders use.

Rate shopping strategies

During your search for a car or home, think carefully about how much money you’ll be using as a down payment, and how much you’re comfortable borrowing. The more money you have for a down payment, the less you’ll pay in interest. This can be especially helpful when interest rates are high. You may qualify for more money than you need, but you don’t have to use it all.

As you continue shopping, start getting your financial information in order. The documents you’ll need for an application will vary based on the type of loan and the lender you work with. Get the relevant financial documents ready in advance to help speed up the application process and finish your rate shopping in a short time to increase the chance that your inquiries are treated as just one inquiry. It can be a project to get all the information together, but it’s a good opportunity to organize your finances for the long-term. Back up your information digitally and have a secure place for hard copies of your documents — you’ll likely need them again someday.

Rate shopping is important but often overlooked. With a plan, you can reduce the negative impact many hard inquiries could have on your credit score and keep control of your credit health as you take this exciting step in your financial journey. If you think you’ll be making a large purchase soon but your credit isn’t where you want it to be, you can learn how to take steps in the right direction with our blog How to Rebuild Credit.