Can you hurt your credit score by applying for multiple pre-approvals?
A home loan pre-approval is highly recommended for those buying a home. Home loan pre-approval from a lender gives buyers an idea of what they can borrow and therefore which properties they can realistically afford. The property market can be very competitive, and a pre-approval indicates to real estate agents that you are a serious contender when you find a property. It would then make sense that a buyer with multiple pre-approvals would position themselves as an even stronger contender. Surely a number of pre-approvals increases a buyer’s chances of actually having at least one lender formally approve their application? Although the reasoning is sound, the opposite is true.
Applying for multiple pre-approvals does not improve your position as a buyer and certainly not as a borrower. Let’s take a look at how a pre-approval application affects your credit score and how applying for multiple pre-approvals can actually have a negative impact on your credit report and score.
What is a credit score?
Your credit score is a number that indicates to a lender the risk involved in lending money to you. A credit score is based on analysis of your individual credit report which includes:
● personal details such as age and location
● credit history including lenders you have used, loans you have applied for and the amount borrowed
● unpaid or overdue loans
● payment defaults
● debt agreements and history of insolvency
● credit enquiries
A credit score is recorded by national credit reporting bodies (CRBs). Depending on the credit reporting body, your credit score is a number between 0-1000 or 0-1200. A high number corresponds with a good credit score and low risk to lenders while a low number is indicative of a bad credit history and therefore a high risk to lenders. The credit score number is scaled into one of five categories that includes below average, average, good, very good and excellent.
Who determines my credit score?
Credit reporting bodies collect data from financial institutions to create your personal credit report. The information contained in your credit report is then used to generate your credit score.
You can check your credit score for free using a number of online providers. It should be noted that there are four different credit reporting bodies that operate in Australia and a credit score may vary depending on which credit reporting body has been used. For an accurate picture of your credit score you should check your credit score with more than one provider.
What are the benefits of checking your credit score?
Credit reporting systems are not infallible, and errors do occur. Detecting errors early before they impact on your financial situation is a major benefit of checking your credit score. If your score seems unusually low, you can request a copy of your credit report and check that all details are correct. Information contained in your credit report may be incorrect, out-of-date, incomplete or irrelevant.
If this is the case, you should contact the credit reporting agency to have the issue resolved. Provided you have evidence, you are legally entitled to have incorrect information changed.
If you find mistakes on your credit report, such as applications for credit that you did not make, it may be that someone is using your identity to apply for credit. This practice is on the rise and protecting yourself from identity theft is another reason to check your credit score.
It is also beneficial to check your credit score before you submit a pre-approval application as it could make a big difference to the amount a lender is willing to lend you. If you discover that you have a low credit score, then it is a good idea to hold off on any pre-approval applications. Instead, you should spend the time improving your credit score. Applying for credit with a higher credit score may help you secure a better interest rate and a better financial product.
Will applying for multiple pre-approvals impact my credit score?
Pre-approval (for those with a property they’d like to purchase lined up) or conditional approval (for those who are yet to find their dream property) are both helpful tools when looking to buy property. They are both formal indications of how much a lender is willing to loan you, though a pre-approval will have had more checks done on the chosen property, showing the lender is satisfied with the hopeful purchase and not just your ability to repay the loan.
Pre-approvals and conditional approvals are not guaranteeing, and the lender is not bound by them, but with one under your belt you can make informed decisions when buying a home. With a conditional approval, you can work out what fits into your budget based on the conditionally approved loan amount and the loan repayment schedule. Real estate agents will be keen to help buyers who have obtained conditional or pre-approval as it shows they are serious about buying a home.
There are different types of conditional and pre-approvals and a pre-approval is not limited to home loans. You can apply for a these on a personal loan or car loan too. If you have a conditional or pre-approval you will still need to formally apply for a loan, so a lender can formally approve your loan amount. If they formally approve your application, you will have final unconditional approval from your lender.
Although a conditional or pre-approval isn’t the same as a formal home loan, during the process it is still necessary for a lender to make an enquiry into your credit file and score, so they can decide how much they would be willing to lend you. This is called a credit enquiry and your credit report will track the details of each enquiry. Recorded credit enquiry details will include the lender, reason for the check and the date of enquiry. Given a credit enquiry is part of the conditional and/or pre-approval process, multiple conditional or pre-approvals will lead to multiple credit enquiries and this can affect your credit score. Let’s take a look at why.
Credit enquiries fall into two categories: hard and soft. Hard enquiries are those enquiries that have been made when you apply for a home loan, car loan or credit card, while soft enquiries are those checks made by yourself, an employer or an insurance company using a reputable provider, like the ones listed here. Soft enquiries do not impact upon your credit score, but hard enquiries do.
A home loan pre-approval is considered a hard enquiry and therefore will have an impact on your credit score. One enquiry in itself is not a bad thing, but multiple enquiries over a short time period can be. This is because multiple hard enquiries may suggest financial stress to a lender and are viewed unfavourably. Applying for credit with multiple lenders is often a sign that someone is having trouble obtaining credit due to a bad history or they are in a financial predicament. A credit enquiry remains on your credit file for five years and during that time it may impact on your borrowing capacity.
Should I apply for multiple conditional or pre-approvals?
When looking for the right financial product and the interest rate the advice is always to ‘shop around’, but when you apply for home loan pre-approvals the opposite is true. Applying for multiple conditional or pre-approvals can have a negative impact on your credit score.
Research is still important, but it should be done well before you formally apply for a conditional approval. A conditional approval should not form part of your research and comparison, rather you should only apply for a home loan conditional or pre-approval once you have decided on a suitable lender.
You can also ask your lender to make recommendations before they make a credit enquiry. This will help you to decide on the best lender without affecting your credit score. A mortgage broker is also helpful when it comes to finding the right lender. They can assess your situation and give you an idea of your borrowing capacity with lenders without making formal enquiries.
What are the best ways to build up my credit score before applying for pre-approval?
Negative information or a ‘black mark’ will stay on your credit report for five years. It doesn’t mean you can’t apply for a home loan, but it’s likely you will pay a higher rate and higher fees. If you don’t require credit immediately then it’s a good idea to improve your credit score before you apply for a home loan conditional or pre-approval.
The introduction of a comprehensive credit reporting system means there is much more you can do to improve your credit score. Under the previous negative credit reporting system, only negative information was recorded on a credit report and consumers would simply have to wait out the five year ‘black mark’ period. A comprehensive credit reporting system means that both positive and negative information is recorded. Even if you have a ‘black mark’ on your credit report, if you can take positive steps toward building your credit score in other areas you may be able to improve your overall credit score.
The following steps may help to improve your credit score:
● Lower the limits on your credit cards
● Consolidate multiple personal loans
● Reduce number of credit cards
● Do not make multiple loan applications
● Focus on making repayments on time
● At least pay the minimum loan repayment
● Pay off credit cards in full each month
● Negotiate a payment plan with your lender before you default on a loan
Applying for conditional or pre-approval
Before you apply for pre-approval you should:
● Check your credit score
● Ensure all details on your credit report are correct
● If necessary, take steps to improve your credit score by demonstrating positive credit behaviour
● Research and compare lenders and/or discuss options with a mortgage broker
● Decide on a lender
● Discuss your options and possible borrowing power with your chosen lender
A home loan conditional or pre-approval application can often be completed in your own time through an online application process. The information and supporting documentation used in your application is generally the same as that of a formal home loan application, which saves you time later down the track. With the ease of online applications, it may be tempting to apply multiple times, but remember that with multiple applications for credit, even home loan pre-approvals can hurt your credit score.
Find a suitable lender and stick with them to ensure you are given the best rate and a competitive deal on your home loan. With just one conditional approval or pre-approval in your tool box, (and an intact credit score!) all that’s left is to find the perfect property, or in the case of the latter, make the offer. Good luck!
At Mortgage House, we’re no strangers to the property buyer’s journey. It’s a long (but rewarding) one. If you’re thinking of applying for a home loan, you can Apply Online today to get started!