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Unless you have unlimited sources of funds, you will eventually have to borrow money to secure a mortgage, get working capital for your business, and finance other huge expenses, such as college and medical care.
Lenders, however, do not extend loans easily. They have to know you are capable of paying them back on time. To determine this, they will perform a credit check, which can have a huge impact on your credit score.
What Is a Credit Score?
A credit score is a numerical value that indicates an individual’s creditworthiness. Credit scores are calculated by credit bureaus, which the United States has three: TransUnion, Equifax, and Experian. Lenders then use the score to determine whether or not to extend credit.
Many factors go into calculating a credit score, including payment history, length of credit history, and outstanding debt.
Payment history is the most important factor in calculating a credit score, and it accounts for 35% of the score.
Length of credit history and outstanding debt each account for 15% of the score, while new credit accounts for 10%. The remaining 5% is determined by other factors, including the type of credit and use of credit.
Keep in mind that this is just a general overview of how credit scores are calculated. Each bureau has its specific formula. The methods of calculating the score can also change over time.
However, understanding the basics can help you make informed choices about your financial future.
What Is a Credit Check, and How Does It Work?
A credit check is a procedure whereby an organization checks an individual’s creditworthiness.
This can be done for the purpose of approving a loan, granting credit, or renting property.
There are three types of credit inquiries:
- Hard inquiries are made when an organization is considering extending credit to an individual, and they pull the individual’s credit report to help make their decision.
- Soft inquiries occur when an individual checks their credit report or when an organization checks an individual’s report for the purpose of pre-screening them for an offer of credit.
- Voluntary inquiry occurs when an individual provides their consent for an organization to check their credit report.
The information contained in a credit report includes personal information (e.g., name, address, Social Security number), account history (e.g., type of account, payment history, balance), public record information (e.g., bankruptcies, tax liens, foreclosures), and inquires (i.e., who has accessed the report).
Based on this information, a credit score is calculated, which lenders use to assess an individual’s creditworthiness.
Generally, the higher the score, the better the chance of being approved for a loan or receiving favorable terms.
How Long Do Credit Checks Stay on Your Credit Report and Affect Your Score?
Most credit checks will stay on your credit report for two years. This is the case for both hard inquiries, which are initiated by creditors.
Hard inquiries usually affect your credit score since they indicate to lenders that you are looking for new credit.
For this reason, it’s best to limit hard inquiries to when you’re actually shopping for a new loan or line of credit.
Fortunately, multiple hard pulls at any given time may count as one. Also, the negative effect on your credit score should not be longer than a year.
Soft inquiries or pulls, on the other hand, do not affect the credit score. Some bureaus may not even include them in the report.
Can You Get a Copy of Your Credit Report?
Yes, you are entitled to a free copy of your credit report from each of the three credit bureaus once every 12 months. You can request your report online, by phone, or by mail.
When requesting your report, you will need to provide some personal information, such as your name, address, Social Security number, and date of birth.
You may also be asked to provide proof of your identity, such as a driver’s license or passport.
Once you have provided this information, the credit bureau will send you a copy of your report. Review your credit report regularly to ensure accuracy and catch any potential fraudulent activity.
If you find any errors in your report, you can file a dispute with the credit bureau.
How to Improve Your Credit Score if It’s Been Affected by a Credit Check
If your credit score has been affected by a hard inquiry, there are several things you can do to improve your score.
- Make sure that all the information on your credit report is accurate. If you find any errors, file a dispute with the credit bureau.
- Focus on making all your payments on time. Payment history is one of the most important factors in determining your credit score.
- Try to keep your balances low. Your credit utilization ratio, which is the amount of debt you have relative to your credit limit, is another important factor in determining your score.
- Be careful when shopping for loans. Multiple hard inquiries in a short period of time can have a negative effect on your score. If you’re not sure whether you should apply for a new loan, you can get pre-qualified for a loan without triggering a hard inquiry. This will give you an idea of whether you’re likely to be approved for the loan and what interest rate you may qualify for.
- Use a credit monitoring service to track your credit score and see how it changes over time. These services typically offer other features, such as alerts if there is any suspicious activity on your account.
Final Words
Credit checks are a necessary part of applying for credit, but they can have a temporary negative effect on your credit score.
By following these tips, you can improve your credit score and get back on track to financial success.
