How Does a Credit Check Work?

How Does a Credit Check Work?

If you apply for a loan, mortgage, or any other form of credit, one of the very first steps the lender will take is to look at your credit history to determine whether to approve or decline your application.

This is done by the lender conducting a credit check. Whilst some brokers will carry out credit checks, it is often the direct lenders themselves, like Moneyboat, that carry out a decisive credit check to make an informed assessment as to whether or not you are suitable for the loan you’re applying for. But what is credit? How exactly does a credit check work, and how are credit reference agencies connected to them?

What is credit?

Credit means you can get things or services now and pay for them later. It's based on the idea that you'll settle the payment in the future. There are three kinds of credit:

Revolving loans

Revolving credit includes things like credit cards, where you have a set spending limit, and you make payments to cover an ongoing balance over time.

Instalment loans

Mortgages, vehicle loans, personal loans, and store financing are all considered instalment loans. You borrow a specific amount, and then you make regular monthly payments to gradually pay off that fixed amount until it's fully repaid.

Open credit

Open credit involves ongoing payments that may never be completely paid off. While various expenses might seem like they fit this description, open credit specifically includes utilities such as electricity, water, heating fuel, mobile phone, and satellite services.

In any case, when you borrow money, lenders trust that you'll repay it. However, trust has its limits, so lenders rely on essential tools like credit reports and scores. These tools help them assess how reliable you are by examining your financial history.

What is a credit check?

A credit check reviews a person’s financial situation and history. When you apply for a new loan of any kind, from payday loans to mortgages, lenders will almost always carry out a credit check. The lender will use a credit check to evaluate the borrower’s ability to pay the loan money back. It ultimately helps to determine a person’s eligibility for the loan.

In order for lenders to carry out a credit check on you, they will need to access your financial history, which can be obtained from any of the three main credit reference agencies in the UK: Experian, Callcredit and Equifax. The potential lender checks with one of these agencies to find out your creditworthiness, based on information from other creditors you have accounts with.

How does a credit check work?

A credit check will generate a credit report, which is then used to calculate your credit score. A credit score assesses the risk of providing credit to you, and is based on various factors. These factors can vary depending on the lender’s individual criteria.

Your credit score will determine whether or not the lender will accept your loan application. Higher credit scores indicate better creditworthiness, whereas lower credit scores suggest lower creditworthiness.

What is a hard credit check?

A hard credit check involves carrying a detailed search of your financial history i.e. credit record. When applying to borrow credit, a lender will almost always carry out a hard credit check to determine your suitability.

It is visible to lenders and shows that you’ve applied for credit. It’s important to bear in mind that if you apply for lots of credit in a short space of time, the lender might deem you to be heavily reliant on borrowing, or suspect that you are experiencing financial difficulties. A hard credit check is usually carried out when you apply for a :

• Credit product such as a credit card, auto loan, personal loan or mortgage

• Mobile phone contract or utility service

What is a soft credit check?

A soft credit check is a quick credit check that provides a snapshot of your financial history. It takes place when you check your credit score or request a company to check it on your behalf.

The check is not visible to lenders in the way that hard credit checks are. It will leave no trace on your credit record, and will therefore not affect your credit score. It can be used to identify which financial products you might be eligible for without applying. A soft credit check usually takes place when you:

• check your credit score

• use price comparison search engines

• use an eligibility checker tool

What goes into a credit report?

Your credit report is a detailed summary of your borrowing profile. Each credit account you open appears on your report, along with the date it was opened, its type(mortgage, auto loan, credit card, etc.), beginning balance or spending limit, payment history, current amount owed, along with other details.

What does a credit check show?

Both soft credit checks and hard credit checks show the following information on your credit file:

• Your full name

• Date of birth

• Current address as well as previous addresses you have lived at

• Any open accounts for mortgages, loans or credit cards (included in this section will be the amount you requested to loan, as well as when these accounts were opened)

• Joint accounts you have open

• Accounts closed in the last six years

• If you have a history of CCJs

• Bankruptcy

Where do credit scores come from?

Your credit score is basically a grade on how well you’re holding up to the test of borrowing. Each credit bureau has its own scoring system, but they’re all fairly equal. For the most part, scores can range anywhere from 300 to 900 and are broken down into the following categories:

• 300 – 550: Bad

• 551 – 649: Poor

• 650 – 699: Fair

• 700 – 749: Good

• 750 – 900: Excellent

When determining your personal credit score, these agencies look at how many accounts have been opened in your name, how timely your payments have been, how much you owe, whether or not you’ve left any outstanding balances with creditors, any defaults you have on file and a number of other aspects.

Scores are also dependent on the types of credit you have. Creditors and reporting agencies like to see diversity when you’re looking to borrow money. Several different store accounts on their own probably wouldn’t boost your score very much even if they’re all active and up-to-date. Along those same lines, having all your credit stem from credit cards wouldn’t work in your favour.

Having a well-rounded profile consisting of, maybe, a personal loan paid off some time back, a mortgage, a vehicle finance and a credit card, all of which have been tended to promptly, could paint a credit-worthy picture of you in the eyes of potential lenders.

Obviously, a low score tells lenders you’re not very adept at paybacks when you borrow money. We all know that’s not necessarily the case. Everyone faces hardships and unexpected issues. Unfortunately, the numbers tell who, what, where, when and how but fail to explain why. Of course, most creditors aren’t really interested in why.

How long does a credit check take?

A credit check is usually a quick process. It can take a matter of seconds or up to 10 days, depending on the kind of information that has been requested.

What happens next?

Once a lender has access to a person’s file, they will run a credit check and receive a person’s credit score which can range from 0 (a very poor credit score) to 999 (an excellent credit score.) It is worth noting that each credit reference agency uses different metrics in order to determine your credit score, as they all assess slightly different criteria. These are the credit rating systems each of these reference agencies use, and what is deemed to be a good credit score by each of them:

• Equifax: a rating of at least 420 out of 700

• Experian: a minimum rating of at least 880 out of 999

• Callcredit: a rating of at least 4 out of 5

Based upon the score you receive, you will either be approved or declined for the application of credit that you have made, as your credit score is used as a barometer of how ‘creditworthy’ you are, i.e. the likelihood that you will be able to make full repayments on any amount borrowed to you.

How to check my credit score?

It is thoroughly recommended to check your credit score with one of the three main credit reference agencies prior to make an application for credit, as it will enable you to determine if there are areas for improvement (it is important to note that your credit score does not remain static and can improve or worsen over time) before deciding to apply for a loan.

You should check your report on a yearly basis. Some people find themselves having to turn to specific bad credit loans due to their poor credit scores, so it is important to check your before you apply for any loan. This will help ensure you are as well informed as possible prior to applying. You can check your credit report online, or by post.

How to check your credit score for free?

Some credit reference agencies provide you with a basic credit report for free, but you can also access your statutory report for as little as £2. If you are actively trying to improve your current score, you could also look at signing up to a credit report subscription service, where you receive regular updates as to the status of your credit report.

Can I change my credit score?

Although you are unable to directly 'change' your credit score, there are a number of ways in which you may be able to improve your credit score for the future. The major benefit of doing this is that should you successfully improve your score, you will make yourself a much more appealing lending prospect for lenders of loans and credit in the future.

By demonstrating positive financial behaviour, alongside various other supplementary practices, you could open up increased opportunities when it comes to credit, mortgages, loans and even day to day credit-related products such as mobile phone plans.