Credit Checks 101: the What, the When, and the Why
Not all credit checks are the same. Here's a rundown of how they can work both for and against you.
If you have ever applied for a loan, there is a good chance you may have undergone a credit check. Or maybe you have never had a first-person experience with credit checks but are concerned that you will one day.
No matter how you reached this article, you are here to learn why credit checks exist and how they work—maybe even what they taste like.
OK, so maybe not what they taste like. But we will be talking about everything else. Welcome to your Introduction to Credit Checks class.
What is a credit check?
A credit check is a review of your credit report, which can be compiled and made available by any of the three major credit bureaus. Your credit report contains information about your payment history, the current amounts you owe, employment status, and other financial and personal information.
“A credit check reveals your financial history and plays a role in making a decision about you,” Patrick Barnett of The Income Spot explained. “It demonstrates your financial habits and the risk you present. The information contained within the report will indicate payment history, total outstanding debt, total open accounts, and types of accounts. It discloses public records such as tax liens, bankruptcy, foreclosures, and civil judgments.”
The information on a credit report can fluctuate over time, but remember that negative credit information will stick around for a while. Negative credit information can remain on your credit report for seven years, while bankruptcy can linger for up to 10 years.
Types of Credit Checks
There are two kinds of credit checks. Hard credit checks and soft credit checks.
Soft credit checks are often used by companies looking to make you a “preapproved” offer. They do not show up on your credit report and thus, do not affect your credit score. An entity performing a soft credit check does not require your permission to do so.
Hard credit checks are essentially the opposite of soft credit checks in nearly every way. They don’t require your permission and will appear on your credit report. That means you do not want to allow too many hard credit checks in a row or else your credit score will take a hit.
Why do credit checks occur?
Credit checks tend to be performed by lenders when considering the likelihood of a potential borrower or applicant to pay back a loan, but it is far from the only occasion.
“If someone wants to run a credit check on you, it’s likely because they need to make a decision on your character,” said Nathan Wade, managing editor for WealthFit Investing. “Landlords, lenders, and employers all might ask for it. If you’re trying to pull out a loan, then the lender wants to ensure you have a good financial history before approving you for that loan.”
However, as noted above, lenders aren’t the only decision-makers who can run a credit check on you. “Some employers also run a credit check to ensure you as an individual have financial responsibility and stability,” Wade said. “Landlords want to ensure you have the financial ability to afford the listed rent and that you don’t have a bad history paying off bills.”
You might also face credit checks from insurance companies, court orders, and utility companies.
Can you avoid credit checks?
Theoretically, avoiding hard credit checks is easy. Because you cannot be subject to a hard credit check without explicit agreement, you could avoid every hard credit check by just never agreeing to one.
Once you move beyond theory, it becomes a lot more difficult to avoid hard credit checks. Unless you are able to pay for everything—from rent to a car—in cash, then you are probably going to have to face a hard credit check at some point.
The best you can do is to prepare for the credit checks you will have to face. That means either building or improving your credit history and paying down your debts to the best of your abilities.
Build up your credibility
Proper credit card use is one of the most reliable ways to build up your credit history. Even if you cannot qualify for a traditional credit card, you should be able to get a secured credit card. By never spending more than one-third of your credit limit and paying off your bill in full each month, you should be able to make a positive impact on your credit. It is also important to create a budget that will allow you to pay down your debts if you want to see an improvement on your credit report.
Finally, you are entitled to a free copy of your credit report annually and in some other circumstances. Seeing your credit report will let you know in advance what others will see after performing a credit check and allow you to know exactly what will happen if you agree to it. You should also check your credit report for any errors and report them to the proper agency.
Credit checks are likely going to be a part of your financial life. Hopefully this article has helped you prepare for them.
Patrick Barnett has a passion for entrepreneurialism that traces back to his days as a teenager. He is always learning and seeking out ways to refine his skills. Through his blog, he offers advice and training – from niche research to case studies of successful small business entrepreneurs. He is also a licensed private investigator and runs a background check website.
Nathan Wade is a licensed attorney for the State of Hawaii and the U.S. District Court of Hawaii. He holds a law degree with a focus in business and has extensive experience in entrepreneurship and international business. He is also a Managing Editor for WealthFit Investing, a financial education blog dedicated to curating advice on investing, entrepreneurship and money.
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The information contained herein is provided for free and is to be used for educational and informational purposes only. We are not a credit repair organization as defined under federal or state law and we do not provide "credit repair" services or advice or assistance regarding "rebuilding" or "improving" your credit. Articles provided in connection with this blog are general in nature, provided for informational purposes only and are not a substitute for individualized professional advice. We make no representation that we will improve or attempt to improve your credit record, history, or rating through the use of the resources provided through the OppLoans blog.