Rate Shopping Can Hurt Credit Scores

Wini Jackson, 58, wants to buy her first home. But the Los Angeles resident discovered a troubling fact while she was looking for the best deal on a mortgage loan: Rate shopping can sometimes be hazardous to your wealth.

The reason: credit scores. Lenders consider them, among other factors, to determine whether to lend you money and what interest rate to charge. These complex numerical fingerprints--often called FICO scores--can be influenced by all sorts of consumer behavior, including rate shopping.

Credit scorers generally will ignore the sort of intensive rate comparison a prospective borrower is likely to do when shopping for a home or auto loan.

But shopping leisurely for rates over an extended period can be interpreted as a sign that you’re applying for vast amounts of credit. And that’s a red flag that can cut your credit score by as much as 10%, said Craig Watts, a spokesman for Fair, Isaac & Co., the San Rafael, Calif., firm that created the most commonly used credit-scoring program.

In Jackson’s case, the damage was great enough to make her ineligible for many mortgage programs aimed at borrowers with excellent credit records. Her ineligibility for lower-interest loans landed her in a category intended for higher-risk borrowers, who often pay thousands of dollars in additional interest charges for a loan.

“A little while ago, I didn’t even know that credit scores existed,” fumed Jackson. “Now they tell me that my score dropped 50 points because someone made an inquiry about me. What is this? They are changing my whole life, saying what I can have and what I can’t have.”

Where do credit scores come from? They’re created by a computer program, most commonly designed by Fair Isaac. The program assigns numbers to information on your credit report, such as the number of credit cards you have outstanding, the length of time you’ve been managing credit, the amount of credit you have available and the number of times you’ve paid late or defaulted on a loan. The scores range from a low of about 300 to a high of 900. Generally speaking, a score of 700 or more gets you the best credit and fast loan approvals. A score between 600 and 700 generally qualifies you for a loan, but not always at the best interest rate. A score below 600 classifies you as a relatively high default risk, making it likely that you’ll either be turned down for a loan or offered credit only at very high interest rates.

Mortgage lenders like to see scores of at least 620, and 660 or higher is considered very good. Scoring above those thresholds typically qualifies borrowers for the lowest-rate loans. Those who fall below get lumped into a “B” credit category, which means they still can get loans but are likely to pay interest rates one to two percentage points higher.

On a 30-year mortgage loan of $100,000, each percentage point rise in the rate costs about $850 a year. Over the course of the loan, that will add up to roughly $25,000 in additional interest charges.

Unfortunately, sometimes an innocent act--such as rate shopping--can push you out of the top tier, as Jackson’s story illustrates.

She started with a credit score between 689 and 702. But the last time Jackson inquired about a loan, the lender told her that her score was 650--about a 50-point drop. (Your score can vary somewhat depending on which credit bureau’s report is pulled. There are three credit bureaus. Though the bureaus use the same credit-scoring software, the data in your file at each one may vary slightly, creating minor deviations in the scores, Watts said.)

Jackson’s crime? She shopped too slowly and too seriously.

To clarify why this matters, it’s important to understand a little about the credit approval process. Naturally, anyone can shop for mortgage rates by looking for comparisons in the newspaper or on a Web site. This type of shopping has no impact on your credit score.

But if you go to a mortgage lender and ask for a firm rate, the loan officer probably will insist on pulling a copy of your credit report. That’s to ensure that you qualify for the lender’s best rates. Some lenders also encourage you to “pre-qualify” for a loan of a set amount. But each time your credit report is pulled in connection with an offer of credit, an “inquiry” is registered on your report.

Inquiries are a factor in determining your credit score because they can indicate that you’re getting a loan that’s in the loan approval process. And if it appears that you’re applying for lots of loans, it can be interpreted as a sign that you’re in financial trouble.

Because rate shopping is a good idea--it can save you thousands on the cost of a big loan--Fair Isaac attempts to segregate rate shopping from real credit applications by counting all mortgage loan inquiries that are made within 30 days as a single inquiry. The same holds true for inquiries on auto loans, Watts said.

But a problem remains: If you shop slowly--taking more than a month to check rates as Jackson did--the inquiries are no longer consolidated and show up as multiple inquiries. And your credit score could take a hit.

Even lenders that don’t use traditional credit scores--such as Fannie Mae--use loan-approval systems that include many of the same standards as the Fair Isaac models, and also would penalize borrowers for leisurely rate shopping.

Here’s a way around the problem: First, find out what your credit score is. You can pay Fair Isaac or one of the major credit bureaus to find out, or, if you have Internet access, you can go to https://www.eloan.com. This free service does not use the Fair Isaac model, but it’s similar enough to approximate your FICO credit score.

(Fair Isaac and Equifax, a credit bureau, also offer credit scores on the Web. Their service, which can be found at either https://www.equifax.com or https://www.myfico.com, costs $12.95.)

Knowing your credit score can tell you whether you’re likely to qualify for the lowest-rate loans. You can then shop for a loan more casually, simply asking lenders for their mortgage rates for good borrowers or by checking newspaper and Internet-based advertisements and rate comparisons.

Use those good-risk rates as a guide to determine how much you can afford to pay for a house. Then you can limit your serious rate shopping--the kind that requires lenders to pull your credit report--until you’ve found a house you want to buy.

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Times staff writer Kathy M. Kristof, author of “Investing 101” (Bloomberg Press, 2000), welcomes your comments and suggestions but regrets that she cannot respond individually to letters or phone calls. Write to Personal Finance, Business Section, Los Angeles Times, 202 W. 1st St., Los Angeles, CA 90012, or e-mail kathy.kristof@latimes.com. For past Personal Finance columns visit The Times’ Web site at https://www.latimes.com/perfin.

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Racking Up Points

Here are tips for boosting your credit score:

* Check your credit report for errors. If there are eroneous items, write to the credit reporting company and have those items removed.

* Close unused credit card accounts, but only if they were opened recently.

* Leave old credit accounts open, even if you’re not using them, because part of your score is based on how long you’ve had credit.

* Apply for credit only when necessary. New credit applications can lower your score.

* Pay your bills on time, every time.

Source: Times research