What is a credit check and why is it important?

A wide range of financial products and services involve a credit check, meaning you may be subject to a credit check more often than you think. We’ll take you through what a credit check is, who does them, and why they’re important to help you manage your finances more effectively.

What is a credit check?

According to HSBC, the definition of a credit check (or a credit search, as it may be called) ‘is when a company looks at your credit report to see your financial history.’

So what is a credit report? Your credit report is your credit history and credit activity. It will show any credit products you have had in the past, what you owe currently (if anything) and what your behaviour is like when it comes to making payments on time. 

This is also called ‘credit worthiness’.

How do credit checks work?

It’s important to know that there are two main types of credit check; soft credit checks and hard credit checks. Let’s go through each of these and how they differ. 

Soft credit checks

A soft credit check is typically used to show your likelihood of being accepted for a loan, credit card, or other financial product. Also known as a soft search, this type of check is generally used by lenders so they can offer you a personalised quote.

A soft credit check provides a snapshot of your previous dealings with lenders and how you deal with your finances. It doesn’t provide the same level of detail as a hard credit check. 

The advantage of a soft credit check is that it isn’t visible to other lenders (although it is visible to you if you look at your credit file). This is sometimes called a ‘credit footprint’.

In this case, soft credit checks don’t leave a footprint, but hard credit checks do. If a company does a soft credit check on you, it’s unlikely that it will hurt your credit score.

Hard credit checks

Also known as a full check, a hard credit check is when a lender looks at everything that your credit report contains. 

While a soft check may have been used to provide an initial quote, a hard credit check is used before any final lending decisions are made.

A hard credit check leaves a footprint on your credit file and this means that it can be seen by other lenders. The footprint is typically visible for around 12 months. 

Multiple hard credit checks on your credit report can happen when you apply for multiple lines of credit in a short time. 

What happens if I apply for multiple credit cards?

For example, say you apply for a credit card. Perhaps while you’re waiting for a decision on that, you apply for a different credit card, thinking you’ll be successful. In this type of situation, multiple companies are carrying out hard credit checks on you. 

This can be a red flag for lenders because, by applying for multiple lines of credit at once, they could think you’re in financial trouble. That makes you at higher risk of missing repayments. 

As a result, the lender may reject your application or offer you the product for a higher interest rate.

The reality is that lots of people do have more than one credit card, but chances are they applied for them at different times. We’ve written a useful article about the right number of credit cards to have.

Who does credit checks?

There are lots of situations when an organisation or agency will do a credit check. Let’s look at some of these:

Banks

When you apply for a new bank account, the bank is likely to check your credit. This allows them to confirm who you are, but it also gives them more information about your history of credit. 

Mortgage providers

A mortgage is often the biggest debt that anyone takes on. It makes sense that before lending such a large sum of money that a mortgage provider would want to carefully examine your financial history and credit score first. 

Creditors and lenders

If you’re applying for a loan or credit card, the company needs to know that you can make the repayments. Some buy now pay later providers also carry out credit checks.

They look at your past behaviours as a way of determining this. Your financial behaviours will help them decide if they want to lend to you and how much they’re prepared to lend. 

Payday loan companies are a good example here. We’ve outlined six key things you should know before applying for a payday loan.  

Potential employers 

If you’re applying for a job where you have responsibility for large sums of money or high-value assets, an employer may carry out a credit search. A poor or bad credit score may suggest financial difficulties and could put your application at risk.

Utility companies 

Unless you’re using a pre-pay gas or electricity meter, companies that provide gas, water, and electricity are providing you with a line of credit. These companies send you a bill after you’ve used that gas, electricity or water. 

This means that they may want to assess your ability to make payments when you move into somewhere new.

Landlords and letting agencies

If you’re looking to rent a home, your landlord needs to know that you’re capable of keeping up with your payments. A credit search allows them to explore this.

Government agencies

If you’re responsible for making child support payments or are applying for certain licences, government agencies may access your credit report.

Why your credit score matters 

You have more than one credit score. This can be confusing, so let’s explain how credit scores work.

In the UK, there are three credit reference agencies. Each agency uses different methods of assessing people and so you’ll have a different credit score with each.

The three credit reference agencies are:

• Experian
• Equifax
• TransUnion

Why are credit checks important?

When you look at the number of organisations that use credit searches as part of their decision-making process, it’s clear that the contents of your credit file really matter.

A soft credit search can help you get pre-approved for a range of financial products or it can stop you in your path.

Even when you get past the soft credit check, there is then the hard credit check to consider. If this highlights behaviours that suggest that you can’t effectively manage your finances, then it could harm your chances of being approved or getting a low interest rate.

Credit scores can help protect poeple

The theory behind credit scores is to help someone negotiate a lower interest rate. They can also help protect people from over-borrowing. That’s borrowing more than they can comfortably afford to repay.

Why is your credit score important?

Credit reference agencies typically assign a credit status to everyone for example poor, average, good, or excellent. They also assign you a number (known as your credit score).

If you have a good credit rating, you’ll have a higher credit score (a higher number). People with a good credit rating typically find it easier to secure credit compared to someone with a poor credit score.  

This means that if you know you have a poor credit score, you can take action to help improve it and increase your rating. The payoff for that work can be very beneficial.

This can include being able to access lines of credit previously unavailable to you. Or being given better interest rates than those with poorer credit scores.

How to get small amounts of cash without a credit check

Millions of employees find themselves short of money in the run up to payday. That’s because the timings of when employees are paid and when their bills come out don’t always match up. 

Wouldn’t it be great if you could access your earnings without waiting for payday?

Get paid before payday without a loan or interest to pay

That’s exactly what on-demand pay is. It’s an app that lets employees access some of their wages before payday. It’s quick and affordable and importantly, there are no credit checks.

On-demand pay can be a great way to pay for an unexpected bill without resorting to expensive credit cards, overdrafts or payday loans. Find out more about on-demand pay. 

The information in this article is for general information only. It does not constitute professional advice from Openwage. Openwage is not a financial adviser. You should consider seeking independent legal, financial, taxation or other advice to check how the information in this document relates to your unique circumstances.