Personal Finance 101: Credit Reports, Credit Scores, and Hard and Soft Pulls

pf101Over the last few days, I’ve received a ton of questions about so-called “hard pulls” and “soft pulls” on your credit report and how they affect your credit score. In order to get the full scoop, I did some extensive research on the subject, and here’s the best information I can find. Let’s start off with the basics.

What’s a credit report?
A credit report is a record of an individual’s history of borrowing and repaying. This includes information about lines of credit, late payments, bankruptcies, credit defaults, and so on.

In the United States, three companies, called credit bureaus, are in the business of maintaining credit reports on each person who obtains any form of credit or debt. These three companies – Experian, Equifax, and TransUnion – effectively operate in the same fashion. They have arrangements with almost every major financial institution to report to them the status of their consumer debts. These companies then collect this information and create reports on individuals, then sell these reports to other companies who are interested in issuing credit or loans.

So, for example, let’s say you have two student loans and no other debt. The student loan companies have shared the status of your loan with the three credit bureaus (this is standard procedure, part of the agreement you signed), and the three bureaus have assembled reports on you containing information about these debts. Then, you apply for a credit card. The credit card holder contacts one (or more) of these bureaus and retrieves your report, showing you have two student loans, how much you owe on each, and whether you’ve kept up with your payments. They’ll use this information to decide whether to issue you that credit card.

Because this information is shared by … well, almost everyone, it’s financially worthwhile to keep your nose clean. All sorts of companies rely on your credit report to determine what to charge you and how big of a risk you are, from insurance to mortgage and car lenders. If you make late payments, sign up for mountains of credit cards, or default on loans, you’re seen as a pretty big risk, and you’re going to be charged more for many services because of it.

Why are there three separate bureaus if they operate in almost the same exact fashion? For starters, the three companies collect and report information largely independently of each other (there is limited data sharing, but not full). This is actually useful for you, the consumer, because if one company makes a mistake, then the other two companies can be used as supporting evidence of an error. If just one company existed, it would be somewhat harder to identify and prove errors.

What’s a credit score?
A credit score is just a single number that summarizes most or all of the information in your credit report. Think of it as an “executive summary” of your credit report – all of the information boiled down to just one number.

How is that number calculated? Each of the credit bureaus uses a slight variation on the same formula, but that formula isn’t publicly known. From Equifax:

Why is my Equifax score different from my Experian and TransUnion credit scores?
There are several reasons for variations in your credit score among the different credit reporting agencies and even among different credit grantors:
+ First, your credit score from each credit reporting agency is based on the information in your credit file at the credit reporting agency, and the credit history information each credit reporting agency has about you can differ. This can result in your score at the other credit reporting agencies being different from your Equifax score.
+ Second, there is a slightly different FICO credit scoring model at each of the three nationwide credit reporting agencies due to the differences in credit history information they each have about you. Remember: your FICO score at a given credit reporting agency is only based on the credit data that credit reporting agency has about you.
+ Third, although the FICO® credit scoring model is the score used most often by lenders, each of the credit reporting agencies, including Equifax, has their own scoring models. These other models may evaluate your credit file differently from the FICO® model and, in some cases a higher score may mean more risk, not less risk as with FICO® scores.

The “FICO” mentioned above refers to the Fair Isaac Corporation, a company that developed a fairly standard method for calculating a credit score. Their methods are in standard use by all three bureaus (with slight variations, as mentioned above) and by all of the other lenders and credit-issuing companies that use these reports.

Surely we must know something about how it’s calculated! Fair Isaac has a very consumer-friendly site about FICO scores called MyFICO, which offers these basic guidelines:

FICO scores are calculated based on your rating in five general categories: Components of the FICO score
Payment history – 35%
Amounts owed – 30%
Length of credit history – 15%
New credit – 10%
Types of credit used – 10%

This provides a general recipe of things you can do to keep your credit score high (and your credit report clean).

What’s a “hard pull” and a “soft pull”?
The terms “hard pull” and “soft pull” are very generic terms that describe different features offered by the three credit bureaus. “Hard pull” and “soft pull” each refer to a specific kind of credit report check offered by the bureaus. In general, the big difference is that hard pulls are ones where you’ve granted permission, they indicate that you’re actively seeking credit, they show up on your credit report for everyone to see, and they tend to have a slight negative impact on your credit score. Soft pulls, on the other hand, don’t require your permission, don’t indicate anything about your interest in seeking credit, only show up on the credit report you see, and have no impact on your credit score.

Let’s look at the offerings from each company.

TransUnion refers to “hard inquiries” and “soft inquiries” that generally match the definitions described above. Here’s what they have to say:

What are inquiries?
An inquiry is a record of someone checking your credit information. Inquiries come in two distinct categories: “hard inquiries” that occur when a business views your credit report for the purpose of an application and “soft inquiries” that occur when your credit is checked for other reasons. If you apply for a new credit card, a hard inquiry record will appear on your credit report and may impact your credit. When you check your own credit report, or when it is checked for a pre-approved marketing purpose, it is considered a soft inquiry and will not harm your credit score.

Experian does much the same thing:

Requests by others to view your credit history will show you who has received information from your credit report and who was given your name during the recent past, as allowed by law. According to the Fair Credit Reporting Act, credit grantors with a permissible purpose may inquire about your credit information without your prior consent. This section includes the date of the inquiry and how long the inquiry will remain on your report.

On your personal credit report ordered directly from Experian, information about those who inquired for the purposes of extending a pre-approved credit offer are included for your information. These inquiries are not revealed to creditors and do not impact your ability to obtain credit.

Equifax makes it a bit more confusing:

+ Inquiries are a record of companies and others who obtained a copy of your Equifax credit file. The Fair Credit Reporting Act (FCRA) requires that Equifax disclose to you who requested copies of your credit file. Depending on the reason your credit file was accessed, Equifax generally retains these for one to two years.
+ Some types of inquires you might see on your Equifax Credit Report™ are not reported to others or used in credit score calculations. These include:
PRM Inquiry. A promotional inquiry in which your name and address were provided to a person who made you a firm offer of credit or insurance, such as a pre-approved credit card offer. These inquiries generally remain on your credit file for 12 months.
AM or AR Inquiry. An Account Monitoring or Account Review inquiry in which one of your creditors performs a periodic review of your credit file in connection with reviewing your account. These inquiries generally remain on your credit file for 12 months.
Equifax, ID, ACIS, or UPDATE Inquiry. Internal inquiries that indicate Equifax’s activity in response to your contact with us, for either a copy of your credit report or a request for research. These inquiries will generally remain on your file for 24 months.

To summarize, all three companies allow others to access your report and also record those who access it. A good rule of thumb is whenever you give someone permission to look at your credit report, it will be on your credit report for everyone to see and will give you a slight short-term negative on your credit score. Those are generally referred to as “hard pulls” – anything else (where you didn’t give permission) is a “soft pull” and won’t affect your credit score.

Recently, many banks have begun doing a “hard pull” on your credit report when you sign up for a new savings or checking account (asking for permission in the initial agreement). Not all banks do this (yet), but a sizeable number do.

Another tip: if you’re shopping around for a mortgage or an auto loan, don’t worry about hard pulls. According to Trans Union, the FICO model accounts for this:

You can still shop around for a loan; multiple inquiries for the same purpose in a short amount of time are commonly grouped into one less harmful inquiry session. Inquiries are also helpful for consumers because they can notify you of a potential identity thief applying for accounts in your name.

In general, you shouldn’t worry too much about the occasional hard pull, especially if you don’t have any major loans coming up. The “cost” of a hard pull is slight on your credit score, often not nearly enough to impact anything. You should only worry if you’re applying for a bunch of different kinds of credit very quickly or if you are looking at a major loan in the near future.

What can I do to maximize my credit score?
There are several very basic things you can do to keep your credit high, and the tips come from the components of the FICO score mentioned above:

Payment history – 35%
Amounts owed – 30%
Length of credit history – 15%
New credit – 10%
Types of credit used – 10%

In other words…

Pay your bills on time. Don’t get behind on any of your bills. Pay them on time and make sure that at least the minimum payment is made.

Keep your debts low. Don’t push your credit cards to the maximum. Instead, keep the balances as low as you can.

Keep your oldest credit cards. If you cancel your oldest card, you reduce the length of your credit history. Keep it around with a zero balance in a safe place.

Don’t apply for new credit cards on a whim. For example, if you’re at a store and you’re being offered the store credit card, just say no, especially if you’re going to be using your credit report for something else in the near future.

Having no debt but credit card debt looks bad, too. If you have a bunch of credit cards and no other debts, you look potentially risky. If you are debt free, keep the credit card count low.

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  1. Nick says:

    Since inactive accounts remain on your credit report, wouldn’t they count as part of your credit history, too?

    Does it make more sense to close a credit card account you don’t use or to keep it open just because it’s the oldest one you have?

  2. Tyler says:

    I’ve heard of a few libraries sending you to collections if you don’t pay your library fines. This, in turn, can even affect your credit score.

  3. prodgod says:

    An inactive account should not be closed because it helps balance your credit/debt ratio.

  4. Wonko Beeblebrox says:

    ever notice that your actual income plays no part in your credit score? Seems like a big oversight to me….

  5. I agree with Wonko! It seems like 100,000 dollars of debt for someone who makes 30,000 dollars a year should be a bigger deal on their credit score than for someone who makes 150,000 dollars a year!

  6. Yynatago says:

    Your current and potential income plays an important role in working out whether or not you can pay off a new loan, but that is the lender’s responsibility.

    Checking your credit report is just part of the loan application process. The credit rating assesses how good you are at paying off debt and monitoring how much debt you’ve got left, not your potential to paying it off.

  7. steven says:

    Dave Ramsey says your credit score could be called your “I love debt” score and that since he doesn’t borrow money, his score is 0. You could have a million dollars in the bank and still have a poor credit score. If a business wants to judge you on this, then find someone else to do business with.

  8. Lurker Carl says:

    FICO doesn’t require your income level because spending habits reveal your fiscal responsibility. Debt versus income shows up in your payment history, debt:credit ratio and new credit applications.

  9. Bob says:

    My wife had her oldest credit card tucked away and kept a zero balance on the account. She recently received a letter from the bank to notify her that the account had been closed due to inactivity! If you are keeping your oldest card around with a zero balance to maintain the length of your credit history, it might be worth pulling it out and using it every once in a while so this doesn’t happen to you.

  10. hogan says:

    Hi,

    Just wanted to send out a message about a website I created (http://www.finmind.com) for personal finance since it could help out people here. I used to do all my finance stuff on Excel, but that was a pain because I had different versions floating around on different computers.

    This website does stuff like track expenses, create a budget, etc. If you want to give it a try, visit http://www.finmind.com. It’s free and I am not making any money off of it (no ads). Send me any comments if you have feedback or suggestions.

    Thanks,
    Hogan

  11. Allison says:

    I have a question: a month ago I noticed that a fraudulent company (“Clear River, LLC,” check out ripoffreport.com) had placed a small charge on my husband’s credit card. We told our CC company and they refunded the charge, but now I’m wondering if it would be safer to just close this CC account, even though it’s his oldest credit card. Thanks!!

  12. Sam says:

    Additionally, you could add positive information to your report.

    The more information you can provide about yourself, the more comfortable lenders may feel extending credit to you. In addition, certain information — such as having the same job or address for a few years — can make you appear to be more stable in lenders’ eyes. While this information isn’t used in creating your credit score, it’s often used by lenders in addition to credit scores to make lending decisions. You may also find that your report doesn’t include credit accounts or other information that it should.

  13. Tom says:

    Yes, something is wrong – I’ve signed up for email feeds and received this post 41 times. 42 now. They keep coming. I’m going to have to unsubscribe and come back when it’s fixed.

    I like your rule of thumb but it doesn’t show up as a hard pull everytime you give someone permission to pull your credit score. Prosper and the other p2p lending compnies, for example, are soft pulls.

  14. spaces says:

    Allison, IMO he should not close that account as it will reduce his credit history. But he could ask the creditor for a new account number.

  15. K says:

    One thing to add is that you do not need to take out a loan or a credit card to build your credit score. Paying rent and utility bills on time, especially cell phone bills, will build your credit score. And although I haven’t checked Dave Ramsey’s score, I can pretty much guarantee it’s not zero. I have never had a credit card or any debt and my score is 803.

    One question about your last point… What if you have no debt because you pay cash for your house and cars? Will getting a credit card lower your score even if you pay it off monthly? You wouldn’t carry a balance, but for 1 month periods at a time, you would have a balance, and that (and possibly your utility bills) would be your only debt.

  16. tresa says:

    But prompt payments do not showup on your credit report, unless they are payments on debt. Cable, phone, rent, and other standard service bills do NOT show up.

    If they did, people living without credit cards who were responsible would have great credit.

    I’ve heard a rumor that you can request something be reported to the credit agencies- how would one do this? I’ve never had a credit card or a loan, but I’ve paid bills on time for thirty years. My credit is apparently horrid/nonexistent.

    How can you fix this, short of actually getting a subprime card and paying huge fees? There seems to be no way to apply prompt payments of regular bills to a credit report- only failures to pay.

  17. Briguy says:

    @ Allison:
    I had something similar happen to me earlier this year. What you need to do is tell the credit card company that there was a fradulent charge on the card, and they’ll issue a new one… all this does is affect the account number, not the number of years he’s had the account; on the credit report, it will have the old account listed as “card lost or stolen” and the new account will be listed as being held the same number of years as the old one. (I just pulled my free annual credit report last night, and this was the case)

    As an aside, freeannualcreditreport.com is really easy to use, and is actually free. Though you can only pull your free report once a year, and it doesn’t give you your SCORE for free, there’s a lot of useful information in your credit reports that should be checked for accuracy. (I found a couple of small errors that were no problem to correct, I did it right through the site.)

  18. Matt says:

    I don’t know if this helps any, but we’ve just pulled our credit reports, and we are at about 750 (averaging the big three credit agencies).

    I open cards to get the deals, pay the card, and shut them down. The longest credit history I have is one I’ve had for only 3 years. I constantly open and close accounts to rotate my debt to 0% introductory fees. Half my cards are maxed out (the 0% fee cards), and I pay all my cards on time (credit cards that I use for Rewards that don’t have 0% fees, I pay in full each month). I have plenty of money in the bank to pay them off, but…. why bother, with 0% financing?!

    My point is that the most important thing is to pay your cards on time. You can have multiple credit cards. You can have a high amount of available debt. You can open and close credit cards relatively frequently, and you can even have a credit history of only a few years. If you’re shooting for a credit score of over 720 (generally consider A+ credit), you really only have to pay your bills on time. Could I be nearer to 800? Of course. Does it really matter, when all I have to do is pay on time each month? Not at all.

  19. Jane says:

    And Dave Ramsey is an idiot. What a mindless thing for him to say. Where does he live, on Mars? Doesn’t he know that (like it or not) one’s credit score is for a whole lot more these days than getting into debt? Your insurance premiums are determined by your credit score. Like or not most employers look at credit scores before even considering an application from a prospective employee. A credit score in our society is now a character reference. And by the way it is impossible to have a score of 0 so for him to say that is just further evidence of his idiotness. Sheesh!

  20. Khaki says:

    Trent says,”Keep your oldest credit cards. If you cancel your oldest card, you reduce the length of your credit history. Keep it around with a zero balance in a safe place.”

    Had a card for going on 20 years, but did not receive good customer service. Actually received poor service on multiple occasions. Requested to close the account and the supervisor argued with me that since I had the card so long that it would lower my credit score. Told ‘em I didn’t care, that I wanted the account closed. I rarely used this card anyway. It seemed that they knew my legnth of history and figured that they didn’t have to accomodate me with lower interest rates, etc…that I wouldn’t go anywhere to preserve my score.

    My credit score was excellent prior to closing the account, and while the score may have dropped a couple of points it remained in the excellent range. If you want to close an account, go ahead! Just be careful if you are buying a house or securing a big loan where you need every point of your score…but after that, close it!

  21. tarits says:

    hi trent, this comment if off-topic, but received 70 email notifications from you about this post over the past week. there may be something wrong with your RSS feeds.

    thanks!

  22. Justin Reese says:

    If you are debt free, keep the credit card count low.

    Number of cards, or amount of available credit? I’ve only got three credit cards, only one of which I use (to separate my business expenses, which I pay off every month), but the combined credit limits are about half our annual household income.

  23. Johanna says:

    @K: I have one credit card that I pay off monthly (and no other debt – I’ve never bought a house or car) and my credit score was around 770 the last time I checked.

    The main thing to watch in situations like that is your debt to credit ratio. If your credit limit is $1000 and you charge $900, then that counts as using 90% of your credit limit, whether you pay off the balance at the end of the month or not. If you routinely charge and pay off $900 or so per month, ask for a credit limit of $5000 or so. Getting your limit increased will ding your score a little, but it’s a one-time thing, and you’ll be better off in the long run because you’re using a lower percentage of your limit.

  24. Patrick says:

    It is not impossible to have a FICO score of 0, Dave Ramsey has not barrowed money in 20 years, when he pulled his report, it came back “I am sorry there is not enough information to calculate a FICO score in your file”. Cell phone and utility companies do not report monthly to the credit bureaus. It will however if the account goes into collection.

  25. Nicole says:

    When I went to the Experian website they forwarded me to the highly publicized freecreditreport.com Unfortunately, they make it really difficult to unsubscribe and they’ve been charging me 15 dollars for the past couple months until I realized the mystery charge was them. I would recommend avoiding them as much as possible, just FYI :)

  26. NicoleS says:

    I have a question…what are the laws about old accounts and credit reports? I’ve heard that a delinquent account is purged from your report after 7 years – but what happens if the collection is sold or transferred or reopened? How long can it stay on your report? And if it’s on your report past the limit, how do you get it removed? Is it the same for all delinquent accounts – phone bills to car repos?
    Any help you can provide is greatly appreciated!

  27. ellie says:

    Help, I cosigned with my son on his school loans. The total amount $20,000. I was unaware that he was not paying them and the letters went to my xhusbands house.. Now, my credit score is ruined. I have talked with my son and he is working on things. Anything I can do?

  28. Jane says:

    I had a similar experience to Ellie… Except is was my sister… I helped her get a car last summer and she quit paying and got it repo’ed….

    I was able to find a good list of FREE credit reports at cardtrak(dot)com/credit_reports

    If you are good about it, just sign up for the one you want and cancel really quick… It saves me money!

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