Do Banks Run Credit Checks? When and How They Work
Demystify bank credit checks: learn why and how they're used to evaluate your financial standing.
Banks frequently conduct credit checks to evaluate the financial standing of individuals applying for various products and services. This process allows financial institutions to assess the level of risk associated with extending credit or offering certain account features. Understanding how and when these checks occur can help individuals navigate their financial interactions with banks.
Situations Requiring a Credit Check
Banks commonly initiate credit checks when individuals apply for financial products that involve borrowing, such as loans and credit cards. For instance, applications for mortgages, auto loans, or personal loans typically trigger a comprehensive credit assessment to determine repayment ability. Similarly, applying for a new credit card or a line of credit will involve a review of an applicant’s credit history. This allows banks to gauge the likelihood of on-time payments and overall creditworthiness.
Opening certain types of bank accounts can also lead to a credit check. While opening a basic checking or savings account usually does not involve a traditional credit score check, banks may perform one if the account offers features like overdraft protection. Overdraft protection functions as a line of credit, prompting the bank to assess the applicant’s credit risk. Banks generally use these checks to determine eligibility and to set appropriate terms for the financial product.
Types of Credit Inquiries
There are two primary categories of credit inquiries: hard inquiries and soft inquiries. Each type serves a distinct purpose and has a different impact on an individual’s credit score.
A hard inquiry, sometimes called a “hard pull” or “hard credit check,” occurs when a lender reviews a person’s credit report as part of a formal application for new credit. This type of inquiry is typically triggered when applying for a mortgage, car loan, personal loan, or a new credit card. Hard inquiries can temporarily lower a credit score, usually by a few points, and remain on a credit report for up to two years. Multiple hard inquiries in a short period might signal increased credit risk to lenders.
Conversely, a soft inquiry, also known as a “soft pull” or “soft credit check,” occurs when a person or company checks credit as part of a background review or for pre-approval offers. This type of inquiry does not impact an individual’s credit score. Examples include checking one’s own credit score, pre-qualifying for a credit card, or certain background checks by employers or landlords.
Information Banks Review
When banks conduct a credit check, they analyze specific categories of information within a credit report to assess financial risk. The primary components reviewed include payment history, amounts owed, length of credit history, credit mix, and new credit.
Payment history is a significant factor, showing whether past credit accounts have been paid on time. The amount owed, or credit utilization, represents the proportion of available credit currently being used. A lower utilization ratio generally suggests responsible credit management.
The length of credit history reflects how long accounts have been open, including the age of the oldest and newest accounts. A longer history with positive activity can indicate financial stability. Banks also consider the credit mix, which refers to the different types of credit accounts an individual holds, such as credit cards, installment loans, and mortgages. New credit inquiries and recently opened accounts are examined, as frequent applications for new credit can sometimes indicate a higher risk.