Beware of the “Soft” Credit Check

by on July 24, 2012Jason Van Steenwyk

For property flippers, speed is of the essence. A big part of the flippers’ value proposition to property sellers is the ability to get the owner cash for their houses. Fast. Often within 10 days of making an offer. This is a powerful attraction to the distressed homeowner. People who need to move quickly to take a job, for example, may be willing to make significant price concessions to close out the sale quickly and move on. Put more bluntly – you can buy much cheaper if you can pay fast.

flippers beware the soft credit checkSo the last thing you need is problems at the closing. Any problems with financing on your end can translate into big problems for the seller, too – and a nasty hit to your reputation in the neighborhood as a buyer who can deliver.

Enter the “soft credit check.”

Yes, the lender will be running a credit check on you and analyzing your ability to repay the mortgage on the property. That’s a no-brainer.

What’s less well-known, though, is that the lender also runs a second credit check, called the “soft credit check” just before you actually close.

According to MyFico.com, soft credit inquiries include inquiries into your credit score, inquiries that other companies make to solicit you for credit offers (they buy lists from the credit bureaus) and inquiries from companies with whom you already have an open credit account.

In the real estate context, the soft credit inquiries fall into the third category.

Why do lenders pull a soft report right after the closing? To keep borrowers honest. Many a lender has been stung by a credit situation that has changed significantly between the time the borrower applied for the loan and the time the deal closes. This is true even of people who think they have prequalified. You “prequalified” based on your situation when you applied for the loan. If your credit situation has changed significantly since then, the lenders reserve the right to hit the “abort mission” button.

The soft check doesn’t affect your credit score. The credit ratings agencies do not count the soft credit check against you as an additional credit inquiry – and the process is usually invisible to you.

But the soft check can derail a potential deal, if they find that your credit score at the time of closing is not what it was when you applied for the loan. What kinds of things can throw your deal off?

  • A change in your debt-to-income ratio. If you applied for a mortgage, then signed a big loan on a new truck, this could change your front-end or back-end ratio to the point where you no longer qualify for a loan.
  • A late payment. Did a credit account list you as current one week and delinquent the next? That could be a problem.
  • Cosigning. Did you cosign a friend’s or relative’s loan recently? That could affect the deal as soon as it shows up on your report.
  • Someone else’s late payment. This is not a joke. If you co-signed a mortgage loan, car loan or student loan for someone, and they miss a payment, it goes on your report, just as if you missed it.
  • Racking up a bunch of new hard inquiries. Applying for a bunch of loans, one after the other, is a big red flag to lenders: People with six or more recent inquiries on their credit report are eight times more likely to declare bankruptcy than people who have not made any recent credit inquiries.
  • Closing on another property (for you multi-tasking die-hard flippers out there!).

The worst cases of abuse involve a fraud technique called “shotgunning.” Dishonest con artists and scammers apply for several home loans in rapid succession from several different lenders – cash the checks, and then disappear – leaving lenders holding the bag.

Yes, soft credit inquiries are not unique to the real estate world. But the stakes are usually higher with real estate transactions than they are with other transactions. The seller could be depending on the cash from selling his current home to buy his next home, or to make a move he has already committed to – and you can’t pull the deal together.

The practice has become even more prevalent in recent years – both because banks have become more vigilant, and because Fannie Mae and Freddie Mac both began formally encouraging the process in 2010, after the shotgunning scam became particularly bad. A soft inquiry in the last couple of days before the close gave lenders a fighting chance of identifying these scammers by their recent inquiries, and shutting them down.

This causes hot tempers and potential lawsuits – both of which are bad for business.

The Metrics

Formally, Fannie Mae standards require banks to pass on loans if recent changes to your income or liabilities put your debt-servicing-to-income ratio greater than 45 percent, or if it moves the needle up more than 3 percent. But even smaller movements can make lenders nervous, and even a series of credit inquiries with no new loans on your credit report can cause a lender to say “no thanks,” leaving both you and the buyer with a problem.

The Bottom Line

Now that you’re in the business of flipping, your ability to qualify for credit fast, or to come up with cash to close on new houses quickly, is an important business asset. It’s a vital competitive advantage against other buyers – and you need to protect it. That means not just managing your cash flow to ensure you have the resources on hand to close on potentially profitable deals when the opportunity arises, but also managing inquiries – and keeping them off your credit report between the time you qualify for the loan and the time you actually close on a property.

{ 3 comments… read them below or add one }

kadien October 23, 2014 at 6:44 pm

Goog day. My credit score is 688. I reviewed my credit report on Equifax. There was an inquiry by credit angency (fda) I have 2 credit cards, both in good standing. One has a limit of $1000&$4000. Monthly payments are never late, I’ve recently got an increase on one of them. Why is this agency doing a soft inquiry when I have no over due balance. Thank you.

Reply

Credit Bob February 12, 2014 at 5:21 pm

Don, a credit bureau is under legal obligation (Fair Credit Reporting Act) to disclose all inquiries, regardless of nature, to a consumer. Hard inquiries show to any party that requests a consumers credit report, and are usually the result of an application for a credit product (collection agencies may also pull hard inquiries as they inherited all rights to the account from the original creditor); soft inquiries are ONLY disclosed to the consumer when they access their own personal report.

All inquiries are required to be recorded, and disclosed to the consumer, as a matter of law.

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Don Algama April 22, 2013 at 12:05 pm

Hi,
My question is whether it is a soft pull or a hard pull, will that be recorded as an inquiry regardless of its affect on the score?

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