UAE: Credit eligibility checks can impact your credit score more than you think, here's how
What are ‘hard’ and ‘soft’ credit inquiries, different ways they affect credit score
Dubai: You are probably aware that when you apply for a loan or a credit card, the potential creditor checks your credit report and score.
However, there are other situations that also register as a credit check, like a prospective employer performs a background check, or when you check your credit.
When a lender or creditor asks a credit bureau to look at your credit report, that inquiry may get noted as part of your credit history.
Credit checks can be classified into two broad categories, namely ‘hard’ and ‘soft’ inquiries.
A soft inquiry predominantly occurs in cases where you check your own credit or when a lender or credit card company checks your credit to pre-approve you for an offer.
Although soft inquiries about your credit score happen all the time, hard inquiries into your credit history in most cases won’t happen without your consent.
Here’s what you need to know about these type of checks in detail and the different ways they affect your credit score.
Working behind a hard and soft credit check
When a lender pulls your credit report because you’ve applied for new credit, such as a credit card, a car loan, a home loan or an increase to an existing line of credit, that’s when a hard credit check occurs.
It means that a creditor has requested to look at your credit file to determine how much risk you pose as a borrower. Hard inquiries show up on your credit report and can affect your credit score.
Hard credit checks can affect your credit score because seeking new credit can make you seem like more of a risk to lenders, who may worry about your ability to pay back the debt.
When your credit report is pulled but you haven’t applied for credit, that’s when a soft credit check occurs.
For example: Insurance companies or potential landlords may look at your credit report to assess risk; potential employers may do background checks.
Credit card companies can also pull a soft copy of your credit to service and manage any existing relationships you may have with them. Soft checks do not affect your credit score nor does it show up on your credit report.
Hard credit inquiries don’t hurt your credit score much
The good news is that for most people, the damage from hard checks is minor, usually less than five points off your credit score. One or two credit checks will not significantly harm your credit.
Don’t let concern about credit checks keep you from shopping around for the best deal on auto loans, student loans or mortgages.
Hard credit checks that occur for specific items like these, and that happen within a certain time frame, otherwise known as a ‘rate shopping’ period, are usually treated as a single inquiry.
The credit rating agencies will group those inquiries, such as from several mortgage lenders if you’re home loan shopping, into a single hard inquiry on your report.
While each lender may use a different formula to calculate a shopping period, banking analysts estimate that it’s typically 14-45 days.
When to be cautious about credit checks
New lines of credit represent only 10 per cent of your credit score, according to multiple research conducted globally, but that doesn’t mean you should rack up hard inquiries without giving it a second thought.
Although credit checks are factored into your credit score for only 12 months, they remain on your credit report for two years.
Credit checks can have a greater impact for someone with a short credit history and few accounts, compared with someone who has a long history and wide range of credit experience.
To a lender reviewing your credit report, many hard credit checks in a short time may indicate higher credit risk because it could appear that you are trying to get a lot of credit quickly. The exception is if you rate shop for a car, student or home loan during a short period.
Drops in your credit score can result in higher interest rates when you borrow, which means you pay more over the life of a loan.
When hard and soft credit checks happen
Hard credit checks:
• Applying for a mortgage
• Applying for an auto loan
• Applying for a credit card
Soft credit checks:
• Checking your own credit
• A lender pre-approving your loan application
• An employer or landlord reviewing your credit report with your permission
When hard inquiries happen instead of soft inquiries
So why do hard inquiries occur instead of soft inquiries? While soft inquiries can occur without your knowledge, such as those pre-approved credit card offers, hard inquiries occur when you apply for a loan and the creditor reviews your credit before granting the loan.
As far as determining whether an inquiry will be hard or soft before it happens, you will likely know when a hard inquiry happens, because you’ll have to give the lender consent.
For example, if you’ve ever bought or leased a car, you were asked to sign a credit report authorisation form as part of the paperwork. By signing this document, you are giving the dealership’s financing department permission to perform a hard credit inquiry.
Verdict: How do I protect my credit?
To keep your credit score healthy, avoid hard checks when you can. Try to say no to those store credit cards offered to you at checkout if they don’t make sense in your larger financial picture.
If you rate shop for a car, student or home loan, it’s best to keep it within a 14- to 45-day window so multiple credit checks are recorded as one.
Also keep an eye on your credit report. If you see a hard check you did not initiate, take action to protect yourself from identity theft.