What Does a Credit Check Mean & How It Works
Uncover the essentials of credit checks. Understand how your financial reliability is assessed and its impact on your borrowing power and financial decisions.
A credit check serves as a fundamental assessment of an individual’s financial reliability. Financial institutions and other entities utilize these checks to gauge the level of risk associated with extending credit or entering into financial agreements. This process helps determine a person’s creditworthiness, influencing decisions on various financial products and services.
Types of Credit Checks
Credit checks primarily fall into two categories: hard inquiries and soft inquiries. Understanding the distinction between them is important, as their impact on a credit profile varies significantly.
A hard inquiry, also known as a hard pull or hard credit check, occurs when an individual applies for new credit, such as a loan or a credit card. These inquiries require the individual’s permission and indicate to potential lenders that new credit is being sought. Hard inquiries can cause a small, temporary dip in a credit score and remain on a credit report for up to two years. When shopping for certain loans, like auto or mortgage loans, multiple inquiries within a short period are often counted as a single inquiry to mitigate score impact.
Conversely, a soft inquiry, or soft pull, happens when a credit report is accessed for purposes other than evaluating a new credit application. This type of inquiry does not require the individual’s explicit permission and does not affect the credit score. Examples include checking one’s own credit report, pre-approved credit card offers, or background checks by employers or landlords. Soft inquiries are visible only to the individual checking their own report and remain on the report for up to two years.
Information Assessed During a Credit Check
During a credit check, a comprehensive review of information contained within a credit report takes place. These reports are compiled by the three nationwide credit bureaus—Equifax, Experian, and TransUnion—and present a detailed history of an individual’s financial behavior.
Payment history is a primary component, detailing whether past credit obligations have been paid on time. This section shows records of timely payments, as well as any delinquencies, missed payments, or accounts sent to collections. It is a significant factor in credit scoring models, reflecting a borrower’s reliability.
Amounts owed, also known as credit utilization, is another important factor. This category indicates the total amount of debt an individual carries and the proportion of available credit being used. Maintaining low credit utilization, below 30% of available credit, is viewed favorably.
The length of credit history reflects how long credit accounts have been open, including the age of the oldest and newest accounts, and the average age of all accounts. A longer history of responsible credit management can contribute positively to a credit profile.
The types of credit used, or credit mix, shows the different kinds of credit accounts an individual manages, such as revolving credit (e.g., credit cards) and installment loans (e.g., mortgages, auto loans). Demonstrating the ability to handle various credit types responsibly can be beneficial.
New credit inquiries also appear on the report, indicating recent applications for credit.
Common Reasons for a Credit Check
Credit checks are a standard procedure in various financial and transactional scenarios, serving different purposes for the entities performing them. These inquiries allow organizations to assess the financial stability and responsibility of an individual before making commitments.
Applying for loans, such as mortgages, auto loans, or personal loans, almost always triggers a hard credit inquiry. Lenders perform these checks to determine the applicant’s likelihood of repaying the borrowed funds. Similarly, when applying for new credit cards, issuers conduct hard inquiries to evaluate the applicant’s credit risk and set appropriate credit limits and interest rates.
Renting an apartment or house often involves a credit check, as landlords seek assurance that prospective tenants can consistently meet rental payments. While some landlords might use soft inquiries, others may perform hard inquiries.
Utility companies, including those providing electricity, gas, and water services, frequently conduct credit checks when an individual applies for new service. This is because they extend credit by providing services before payment is collected, and a credit check helps them decide if a deposit is necessary.
In some cases, employment screening may include a credit check, particularly for positions involving financial responsibility or access to sensitive information. These are soft inquiries and are used to assess an applicant’s financial background, without directly impacting their credit score.
Accessing Your Own Credit Information
Regularly reviewing your own credit information is an important step in managing personal finances. Individuals have the right to access their credit reports and scores, which allows for monitoring accuracy and identifying potential issues.
The official website for obtaining free annual credit reports from the three nationwide credit bureaus—Equifax, Experian, and TransUnion—is AnnualCreditReport.com. By law, consumers are entitled to one free copy of their credit report from each of these bureaus every 12 months. However, the three bureaus have permanently extended a program allowing individuals to check their credit report from each once a week for free through AnnualCreditReport.com. Reports can be accessed instantly online or requested by phone or mail.
When reviewing a credit report, it is important to scrutinize personal identification details, account information, and inquiries for accuracy. Common errors can include misspelled names, incorrect addresses, accounts that do not belong to you, or inaccurate reporting of payment statuses. Identifying and disputing any inaccuracies with the credit bureau and the information provider is a recommended action.
While credit reports provide detailed account histories, they do not include a credit score. A credit score is a three-digit number that summarizes the information in a credit report, providing a quick assessment of credit risk. Various scoring models exist, such as FICO and VantageScore, and each may weigh factors differently, resulting in slightly different scores across bureaus. Many credit card issuers and financial institutions offer free access to credit scores as part of their services, allowing for regular monitoring without impacting the score.