Whenever you apply for a new credit product, like a personal loan or a credit card, the lender will do a credit check as part of the approval process.
Below we will look at the differences between soft and hard credit checks and how they can influence your credit score.
A soft credit check is a type of background check a lender uses to evaluate your creditworthiness when you apply for credit.
Most soft credit checks are based on information gathered from third parties like Equifax, who provide your credit report and score.
Soft credit searches typically don't impact your credit score, although they are recorded on your credit report.
An example is a pre-qualification for a credit card.
Another example of a soft search is when you request insurance or credit quotations.
Soft credit checks don't guarantee approval as most lenders use them to pre-screen applicants prior to a full credit application.
A soft credit search is typically used to determine how much interest you will pay and the terms of any loan you will receive.
A hard credit check is when a lender does a full credit history review on you. This is based on information pulled directly from your credit report and it's the most accurate method of determining your creditworthiness.
An example of a hard credit search is when a bank does a full credit assessment when you apply for a mortgage.
Your credit profile will determine how much interest you will pay as well as the terms of the loan, credit card, or other credit product you apply for.
Credit checks are a bit like a safety inspection. The lender will pull your information from one or more of the three credit reference agencies: TransUnion, Equifax, and Experian.
Keep in mind that each credit reporting agency has its own way of reporting and collecting information and you will have a different credit score for each.
Your report will contain a wealth of information about you as an individual. It will include your name, address, birthdate, current and past addresses, income, employment, and payment history. Your report will also include information about any debts you owe, and details about any debts you owe another person, like a spouse.
There are two main aspects that affect your credit score: payment behaviour and credit utilisation rate.
Your payment behaviour will be reported on your credit profile. This includes your payment history, including any late payments and the amount of each payment.
Your credit utilisation rate is the percentage of available credit you are using. This is reported on your report as the amount you have borrowed versus the amount you owe.
Both these factors affect your credit score in different ways. Payment behaviour affects your credit score the most, but it also affects your interest rates. A low credit score can cause you to pay higher interest rates on loans, which can snowball if it happens too often and you end up with higher interest rates on your mortgage or car loan.
There are two main ways to improve your credit score: improve your payment behaviour and decrease your credit utilisation rate. One way to do this is to start paying on time.
A credit report with no debt payments will give you the best credit score possible.
This is because it shows you as a responsible credit user - not someone who takes on too much debt.
How you pay will depend on your specific credit agreement, but whether you're making weekly or monthly payments, make sure that it is paid in full.
The second way to improve your credit score is by lowering your credit utilisation rate. This can be done by making sure that you are using your available credit responsibly.
Only buy what you need with your credit card, and make regular payments to reduce your outstanding balance. The amount of credit you have left in relation to your total available credit is your credit utilisation and the lower this number is, the better.
One way to improve your credit score is to get a co-applicant on your loan or credit card application. That is, have a friend or relative - with a good credit score - co-sign your loan application. This will show the lender that you have collateral for your loan, and the lender may be more willing to grant you approval.
Guaranteeing a loan is a little like putting up security for someone else, as the guarantor will have to make payments if the borrower falls behind. The gurantor will also be held responsible for the full amount of the loan if the borrower can no longer pay.
A soft credit check is typically used to evaluate your creditworthiness without hurting your own credit score with a complete assessment.
A hard credit search involves a full review of your credit profile and it will temporarily reduce your credit score. Hard credit searches are used when you formally apply for a credit card, personal loan, mortgage, or other credit product.
You can improve your credit score by paying on time and lowering your credit utilisation rate. You can also get a guarantor to improve your chances of approval and get better loan rates.