What is a Credit Check? How Credit Card Issuers Determine Risk

I’ve heard that several online dating sites advise singles to check their prospective paramour’s credit before making a match. It isn’t surprising to me that credit checks have become mainstream in this way. 

Credit reports are like personality X-rays. Not only can they reveal when something is broken, but they get to the heart of their habits — in this case, a person’s ability (or willingness) to pay their bills.

A credit check involves accessing a credit report to review the details of your borrowing and repayment history. This can help lenders and other parties estimate whether you’re likely to repay your debts or be approved for a loan. Your credit profile and score reflect how creditors judge your financial risk level.

Now I’ll go over everything you need to know to monitor, manage, and maintain your credit profile successfully so that it has a positive impact on your financial future — and perhaps your dating life!

Credit checks are requests to one or more credit bureaus for your credit reports. They help lenders, employers, landlords, and other interested parties see how well you manage your debts. 

Credit reports spill all the beans regarding the times you borrowed money and when you repaid it – if indeed you did. This snapshot enables readers to decide whether to lend you money, hire you, or lease you an apartment. Or, sometimes, date you.

Components of Your Credit Report

A credit report is divided into several parts, all designed to give readers detailed information about your credit history. Let’s see what they find out when they crack open your reports.

Personal Information

Personal information in a credit report includes your name, address, Social Security number, and date of birth. It also lists past addresses and employment history. It’s a good idea for report recipients to verify the personal identification is correct. It’d be mighty embarrassing to use credit information belonging to the wrong subject. Talk about identity confusion!

Seriously, credit reports need accurate personal information. Think of the chaos resulting from mistaking one person’s credit report for another’s. A disaster like that can mess up your credit rating real good and prevent you from getting a new loan or credit card. 

Thankfully, you can check your own credit reports for free and make sure they’re not telling tall tales. Keeping track of your own credit report information and updating it as needed helps prevent nightmarish mistakes from throwing you under the bus.

Credit Accounts

Credit (or trade) accounts are another big part of your credit report. I’m talking about your credit cards, car loans, student loans, mortgages, personal loans, and however else you’re borrowing money. Each type of account tells a story about how you manage your credit.

Every credit account has all the details about when you opened it, the loan amount or credit card limit, how much you still owe, and all the payments you made. The current balances tell everyone what you owe at the moment, and the credit limits reveal how much you can borrow from your credit cards.

This crucial information unlocks all your debt-related secrets –whether you’ve paid your debts and any late or missing payments. On-time payments are the gold stars that build your credit score, while late or missed ones are like a financial dunce cap – they do your reputation no favors.

Public Records and Collections

Let’s get this straight right away — the information in this part of your credit reports is probably going to make you look bad. It contains the gory details about the times bill collectors hounded you, or you had to file for bankruptcy.

Accounts go into collection when your creditors sell or transfer your debts to a collection agency after you haven’t paid your bill for an extended period. I’m talking about credit card debt, unpaid medical bills, and countless other commitments. 

This dismal report section also records all those times in the last seven to 10 years that you had to declare bankruptcy. For some, bankruptcy is an unfortunate but necessary way to put their financial lives back together.

The public records in your credit reports used to be a lot more extensive. They contained all sorts of nasty things about tax liens and civil judgments. But other unflattering information is still there, including foreclosures, repossessions, and overdue child support.

State laws have a say on what gets included in your credit reports. Most of that stuff remains for seven years — plenty of time to punish your financial wrongdoings.

Hard and Soft Credit Inquiries

There are two types of checks on your credit: hard and soft. Hard inquiries  (or “hard pulls”) appear when a creditor checks your credit report after you apply for a loan for a credit card.

These inquiries can affect your credit score – when too many occur within a short period, creditors read it as a cry for financial help. 

Hard inquiries remain on your reports for two years but impact your credit score for just one. Only you can authorize a hard credit check.

Soft inquiries occur when you or someone else checks your credit record for reasons other than lending—like background checks, prescreened credit offers, and when you request a copy of your credit report. Only you get to see the record of soft inquiries, and they never affect your credit score.

The Role of Credit Scores

The three big credit bureaus — Experian, Equifax, and TransUnion — build credit profiles based on information they receive from lenders, credit card companies, and others. These data furnishers usually send monthly updates to the bureaus.

Updates include data regarding personal information, credit accounts, new loan and credit card applications, debt collections, and other financial activity.

The bureaus run the information through different credit scoring models – typically FICO and VantageScore. These models look at several factors in your history to produce credit scores. The factors include your payment history, the amount presently owed, and the length of your credit history. 

FICO

FICO is the big dog in consumer credit scores. Ninety of the largest 100 US banks use FICO Scores to predict if you’re going to repay your debts. 

There are multiple versions of the FICO Scores, but the two most popular ones are Score 8 and Score 9. These models assign you a score from 300, which is really poor credit, to 850, a perfect reading. The model evaluates five major factors from your credit history to come up with your score:

• Payment History (35% of the total score): This portion records whether you pay your bills on time. You can be late once in a while, but several late payments can clobber your score.
  
• Amounts Owed (30%): This measures how much debt you have compared to your income and to your credit limits. It’s a way of figuring out whether you’re able to take on more debt. This factor includes your credit utilization ratio (CUR), which is your credit card balances divided by your credit card limits. FICO wants you to keep this ratio below 10%. A high CUR — above 30% — tells it you may be relying too much on credit. That’s bad news for your credit score.
  
• Length of Credit History (15%): This is where FICO checks how long you’ve had credit accounts open and if they are still active. A long history of good account management helps increase your score. 

• Credit Mix (10%): This part looks at the types of credit you use, such as home loans, car loans, credit cards, and others. This minor factor shows whether you can juggle a mix of debts.
  
• New Credit (10%): This factor tracks how many new credit applications you’ve recently submitted. In most cases, when you apply for any of the types of credit, the associated hard credit check gets recorded by bureaus. Too many applications in a short period scuff up your score. However, soft checks have no scoring impact.

Don’t expect your credit scores from Experian, Equifax, and TransUnion to match each other. The FICO Score that each one calculates may be slightly different since the way they collect and interpret data is not identical. Still, all three should be reasonably close.

While FICO dominates the consumer credit score market, it still has to compete with VantageScore, another popular scoring model.

VantageScore (VS)

VantageScore and FICO Scores range between a low of 300 and a high of 850; however, VS calculates these scores slightly differently. 

Here’s how VantageScore 4.0 determines your score:

• Payment History (41% of your total score): This factor reports whether you pay your bills when they’re due. Your score will suffer if you’re more than 30 days overdue. The longer you’re late, the worse the damage. Late and missed payments stay on your credit report for seven years, although the damage starts to heal much sooner.
  
• Depth of Credit (20%): This is your average age of accounts, along with which accounts are the oldest and newest. The older your accounts are, the better your score will be since that tells creditors that you’ve been at the rodeo a long time. Depth of credit also includes your mix of credit. There are two major types — revolving and installment — with some sub-varieties. Revolving credit is the type you get from a credit card or home equity line of credit. Installment debts, such as a mortgage or car loan, require fixed repayments on a regular schedule, typically monthly.
  
• Credit Utilization (20%): As previously discussed, your credit utilization ratio considers credit used versus the amount available. This model wants you to maintain a CUR of below 30%.
  
• Recent credit (11%): This factor records the number of new credit accounts you recently applied for, as indicated by the number of hard inquiries on your credit report. VS treats all hard inquiries occurring within 14 days as one inquiry — it’s considered loan shopping.
  
• Balances (6%): This factor considers how much you owe on all your credit accounts, including those on which you’re delinquent. Owing a lot can bring down your score, even if you’re up to date with the payments.
  
• Available credit (2%): This last category reflects how much credit is still available on your revolving accounts, such as credit cards. This does not weigh heavily on your scores.

The newest version of the VantageScore (4.0) also departs from FICO’s score in some ways:

• VS looks at how you’ve managed your debt over time, such as reducing it or making minimum payments. FICO is less concerned with long-term trens.
  

• VS does not count unpaid medical debts.
  
• VS groups together credit checks made within 14 days of each other, so they have less effect on your score. FICO 9 also groups checks, but only for car, home, and student loans over a 30-day period.

How to Access Your Credit Report

You can now get credit reports weekly, for free, from Equifax, Experian, and TransUnion. Paid services add layers of identity theft security, including alerting you when suspicious activity occurs. Most of these cost between $10 and $30 per month. They may be worth it if you’re feeling vulnerable.

Now, don’t confuse your credit report with your credit score. Credit reports give information about your credit accounts and all inquiries. In contrast, a credit score is a number that summarizes the risk that you won’t pay your debts. While derived using the information in your credit reports, the credit score is not necessarily provided with free reports.

It is a smart idea to regularly review your credit reports for accuracy. Erroneous information can drag down your credit score like a boat anchor. Moreover, it can provide evidence of identity confusion or theft. A clean set of credit reports and regular reviews is your best assurance against mistakes and fraud.

Credit checks impact several financial areas, including access and costs. Understanding this can help you do a good job managing your credit.

Approval for Credit Products

Credit card issuers make approval decisions by assessing your credit history and score. This helps them manage risk by approving only those who demonstrate responsible credit behavior. A poor credit report may cause an issuer to deny your card application.

Higher credit scores increase the chances your application for a credit card or loan will be approved. Lenders are most likely to extend credit to you if you have a high credit score (i.e., you’re a low-risk borrower). You’ll likely get better deals if lenders are satisfied you won’t stiff them.

Setting Credit Limits and Interest Rates

Good credit scores can yield higher credit limits and lower interest rates. Lenders reward you with better terms if you manage credit responsibly. Therefore, your good credit history — and reports — give you more borrowing power and lower costs. 

Poor credit scores saddle you with higher interest charges and lower borrowing limits. A poor credit history can also cause you to be rejected outright by credit card issuers – a stinging rebuke indeed.

You can boost your credit report through responsible financial habits. By now, you know exactly what I mean — paying your bills on time, keeping your credit levels reasonable, and diversifying your credit mix.

Make Timely Payments

Paying bills by their due dates makes the difference between crummy credit and a score you can be proud of. Even one payment overdue by 30 days can really harm your credit score.

Timely bill payment has many long-term benefits. It supports your credit score, allowing you to apply for credit cards with lower interest rates.

That will save you money in the long run – you want to save money, don’t you?

Banking websites and apps often enable automatic bill payments, so you can easily avoid forgetting. Personal financial management applications such as Quicken (my personal favorite) also provide timely reminders of upcoming payments. You can also set the app to automatically make payments, so you won’t miss your due dates.

Manage Your Credit Utilization Ratio

What you owe comprises 30% of your FICO credit score, and the credit utilization ratio is included in this factor. As this is a major part of your score, you really want to keep your unpaid balances in check.  

To maintain a good borrowing record, avoid maxing out your credit cards. I recommend keeping your credit utilization ratio well below 30%. For example, if you have a $1,000 limit, maintain your CUR at $300 or less.

Here are some tips to help you manage your credit utilization:

• Pay off your balances regularly: Try to pay your entire card balance each month. If you can’t, pay back as much as possible to minimize your balance.
  
• Limit increases: Ask for a higher credit limit to reduce your CUR – it increases the amount of credit available. Be careful, though — if you ask too often, it will look like a desperate move to some lenders. Wait about six months before requesting an increase to show you aren’t chomping at the bit.
  
• Use multiple credit cards wisely: Spread your purchases e over several credit cards. This helps lower the utilization of individual cards. 

Keeping a low credit utilization helps you look good to creditors. This should enable you to get loans and credit cards with better interest rates.

Diversify Credit Types

Credit mix is really just a small factor when it comes to your credit score. Using various credit types, such as credit cards, loans, and mortgages, is helpful, as it demonstrates you can juggle different types of credit.

However, I advise you not to open new accounts that you don’t need! Sure, multiple hard credit checks in a short period can hurt your score. But the real danger of having too much credit available is that it may tempt you into overspending. It’s the financial equivalent of the morning hangover from drinking a bottle of Jack Daniels.

A good credit check is like getting a gold star on your financial report card. You prove to lenders you’re responsible and can keep your finances in order. 

A high credit score indicates you can and will pay your debts without breaking a sweat. That’s something lenders like to see, so you’ll be rewarded with the advantages of better approval rates for credit products and much sweeter deals on offer. 

With a good credit score, you are likely to enjoy higher credit limits and lower interest rates. That’s the kind of pat on the back you can really use. 

However, if your credit history is a minefield of mistakes, well, that is really going to blow up your access to credit. Here’s the silver lining: You can rebuild your credit starting today, no matter how red, rough, and sore it is. Be diligent, and eventually, you will have nothing to fear from a credit check.