We have all heard stories about how applying for many savings or cd accounts can have an adverse impact on your credit score. According to conventional wisdom, some banks do a hard pull on your credit and these pulls can cause your score to go down, impacting your ability to get a loan or the rate on any loan you open.

So is this really true? What do banks do when you open a savings account, checking account, certificate of deposit, or other FDIC insured account? And how do the credit agencies track what the banks do and apply it to your credit score?

To find out what really happens when you open an account, I spoke to representatives from Experian, Transunion, and Equifax (the big three credit rating agencies), as well as from Fair Isaac, the company whose algorithms are used to calculate your FICO score. Most banks use FICO scores as an important component in determining a potential borrower’s credit worthiness for a loan.

Maxine Sweet, the Vice President of Public Education at Experian explained how Experian records account openings:

• Checking Accounts (DDAs) - Banks have the option of doing a hard pull or a soft pull. Banks need to use a code in their account opening system if they want the pull to be soft. Once overdraft protection or a debit/check card is added it will automatically be a hard pull.
• Saving and Money Market Accounts and Certificates of Deposit. These always result in hard pulls.

Steve Katz from Transunion wrote that whether or not they do a credit check “…really depends on a financial institution’s specific credit policies. Some may pull credit reports for CD’s and savings accounts which would then show as a hard inquiry. Most do not engage in that practice at this time.

Some financial institutions may seek to offer the consumer a credit card or other pre-approved offer of credit in conjunction with the new account. Inquiries for such a permissible purpose would result in only a soft inquiry that has no impact on a consumer’s credit score.”

According to Ms. Sweet, the impact of even a hard pull from this type of inquiry is minimal and short lasting, unless the consumer is already having credit problems. In that case, it becomes another flag that there is something going on and can have a more significant impact on your report. These types of inquiries last about 3 months and then disappear entirely from your credit report.

Ms. Sweet recommended that if you are thinking of applying for a mortgage or a car loan, you not go on an account opening binge in the 3 months prior to applying for the loan.

Craig Watts, Public Affairs Manager for Fair Isaac said that if the savings or CD account is a “hard pull” then the inquiry would be listed on the FICO report and it could have a impact on your FICO score. He said the impact might be a 5 point decrease in your credit score. The impact to a young credit file, that is someone who has just started to build their credit history, might be more significant. Regardless, he stated a string of late payments on credit cards would have far more impact than a string of inquiries from opening savings accounts.

His advice to consumers is to check your credit report, be diligent in managing credit, and mind your Ps and Qs so you don’t have to worry about minor impacts from things like opening a savings account or a certificate of deposit.

Conclusion

• Opening a checking account may or may not have an impact on your credit score, depending on the bank and the credit agency they use. If the account comes with overdraft protection or a check card, assume it will result in a hard pull.
• You can ask the customer service rep or the branch customer service personnel but they may not even understand their bank’s policies. Many do not.
• If a hard pull is done the impact on your credit score varies depending on your other credit history, and your credit age.
• If you have other bad marks on your credit score and are thinking of applying for a major loan (home, car, etc.) you might not want to open a slew of new accounts.
• Any impact on your credit score from opening a savings account, certificate of deposit, or money market account is minimal if you have good credit.

Updated: November 7, 2008

The chart below shows a very interesting trend that we\\'ve seen over the last six months with savings account rates and certificate of deposit rates. Even though the Fed Funds Fund rate (the rates banks charge each other for overnight lending) has fallen since early April, savings and cd rates have actually risen. Note that the divergence started with the near-failure of Bear Stearns, which marked the beginning of an intense period of financial turmoil. Even as the Fed cut rates to 2%, savings account rates, 1 year CD rates, and 3 year cd rates rose. The increase in rates seems to have reached its peak in mid-October with the Fed takeover of Fannie Mae and Freddie Mac, the failure of Lehman Bros, and the government takeover of AIG. The passage of the bank bailout, officially known as the Treasury Asset Relief Program (TARP) as well as a swift cut in the Federal Funds rate from 2% to 1% has slightly thawed savings and cd rates and we are now starting to see a gradual decline in bank rates.

So, why did banks buck the interest rate trend and increase rates? The answer is that the banks were desperate to keep your cash and get more of it. Banks were deathly afraid of the kind of runs that brought down IndyMac, WaMu, Wachovia, and National City.

(Graph shows the average of the top 10 savings account rates, 1 year cd rates, and 3 year cd rates according to the BestCashCow rate tables)

Will the decrease in deposit rates continue? Yes for two reasons:

• If you look at the Fed Funds Futures (instruments that are based on future expectations of what the Fed will do with rates) they are giving high probabilities to a rate cut to either 0.75% or as low as 0.5% by January. Lower Fed Funds Rates will put pressure on bank deposit rates.
• Government efforts to support and recapitalize banks will take some of the pressure off banks to raise money from deposit holders. The Fed has pumped in over $1 trillion dollars into the financial system. Raising the FDIC limit to $250,000 also makes it less likely depositors will withdraw money if they sense trouble and will make it easier for banks to begin cutting rates.

So, what does all of this mean? For a timeframe of between 1-2 years, opening a CD now may get you a higher return than waiting. Based on economic conditions, it looks like banks will be reducing rates. If you want to keep your money liquid in a savings account , you will see a drop in rates, but the drop will not be precipitous. Banks are still hungry for your money and are willing to pay a premium for it. They just aren't as hungry as before.

Check back for further updates and analysis of how economic conditions will impact savings and money market accounts, cds, and more.

The Bank of England today released the October 28 Financial Stability Report which paints a grim picture of the UK and global financial system. While the report focuses on the UK, its analysis and insights are valauble for the US as well.

While the reports says that the banking system has somewhat stabilized, significant risks remain. These include:

Hedge Funds

The report says:

"Recently, hedge funds have also experienced additional funding pressures due to redemption requests and a risk is that these could increase. Redemptions tend to increase following a period of weak returns. In 2008 Q3, hedge funds had one of their worst quarters on record, losing a little over 10% on average (Chart 5.6). Bank contacts report that redemption requests have been high in particular from funds of hedge funds (FoHFs) in the light of their own redemption requests. Hedge funds generally operate ‘gates’ that place an upper limit on aggregate redemptions in any given quarter. A risk for FoHFs is that hedge fund gates prevent them securing the liquidity that they need to meet redemption requests. FoHFs often have liquidity lines with banks on which they could draw in such circumstances. This would transfer the need for liquidity from FoHFs to banks. Hedge fund liquidity needs may help to explain sales of relatively liquid securities such as developed-country and emerging market equities, the prices of which have fallen sharply in September and October."

In plain English, investors are pulling their money out of hedge funds. Many hedge funds are not liquid but have bank lines which they can use to meet investor requests to be cashed out. This puts more of a strain on banks because they must pay out the funds. In addition, the selling we've seen in emerging markets may be hedge funds selling stock to meet redemptions.

No one seems to think we're at the end of hedge fund pressure.

Insurance Companies

Significant risks also remain with insurance companies:

"As long-term investors, insurance companies tend to hold a significant proportion of their assets in equities and corporate bonds. The marked decline in the value of these securities in 2008 has generated capital losses for some UK insurance companies, which is reflected in rising CDS spreads and falling equity prices for the sector (Chart 5.7). Unlike banks and hedge funds, however, insurance companies generally do not employ much leverage and have long-term liabilities. So insurance companies seem relatively well placed to avoid liquidity difficulties. Risks could arise, however, if the value of insurance companies’ investments were to fall below regulatory capital requirements. This was an issue in the bear market of 2003, but regulatory reforms introduced in 2004 have reduced the likelihood of this risk by using a more risk-based capital requirement with countercyclical resilience testing. A second risk is that credit ratings of insurance companies could be downgraded. Counterparts to any derivatives trades would then increase margin requirements, increasing the liquidity needs of the insurance sector."

The BofE seems less concerned about insurance companies.

Solution

Banks are increasingly relying on short term funding to meet their liquidity needs. This creates risk because if the funding dries up, they will not be able to roll their debt over, resulting in default. One of the main solutions the BofE sees to this problem is a return to customer deposits. The Bank writes:

"Over the medium term, banks can reduce vulnerability to rollover risk by financing a greater proportion of customer lending through customer deposits. Such adjustment would result in a narrowing of the customer funding gap. But banks’ willingness to raise customer deposits will be constrained by cost. In the United Kingdom, increased competition for customer deposits has pushed up the cost of such funding."

And there you have it. The explanation for why deposit rates in the United States have not fallen as far or as fast as the drop in Treasuries and the Fed Funds rate. Your cash is a valuable, steady source of funding for banks.

And it will only become more valuable over time. Don't part with it easy and make sure you are getting the best rate on your savings or money market accounts, or CDs.