If you have ever applied for a financial agreement such as a phone contract, credit card, or a mortgage, you will be aware companies ask to conduct a credit check. When you apply for a financial product, you will always be alerted at the stage a credit check is conducted because it can have an impact on your credit score and financial standing.
Companies use two forms of credit check: soft credit checks and hard credit checks. Both allow lenders to access your credit profile, and both provide them with your credit score. Your credit score is then compared to a lender’s thresholds and if your score is higher, you pass and if it is lower you are declined the product.
Soft and hard credit checks have different outcomes in other ways though and in this guide, we explore how to differentiate soft and hard credit checks for better financial management.
What is a Credit Check?
As mentioned, a credit check is a way for lenders to access your financial history and ascertain whether you are a low-risk borrower or someone who might not stick to the terms of a financial agreement.
If you have always maintained your previous financial accounts, making payments on time and clearing debt whenever possible, you will be deemed a responsible borrower and be more likely to secure future finance.
If you miss payments, default on debts, or ignore them entirely, lenders will deem you as a high-risk borrower and you are less likely to secure finance. High risk borrowers sometimes struggle to secure any finance, however there are lenders with lower risk profiles who specialise in providing credit to those with bad credit histories. These lenders balance that risk by charging higher interest rates than traditional lenders.
How is a Credit Score Compiled?
The information accessed by lenders through a credit check is your credit score. The score is a numerical value given to you by a credit reference agency to reflect your creditworthiness.
The better you manage your finances, the higher your credit score. Failing to manage your financial accounts correctly will have a negative impact on your score and it will drop.
Most credit checks are automated processes and if you fail a credit score, you will have limited ability to appeal the outcome. In some cases, for high value finance such as a mortgage, you may be able to ask an underwriter to review the information, but for most forms of credit, the automated process is all that is available to you.
Credit reference agencies track your financial situation over time and your credit score floats in line with this tracking. This means even if you have a bad credit score now, if you improve your money-management you can improve your credit score.
What is a Hard Credit Check?
A hard credit check leaves a mark on your credit profile and as such can change your creditworthiness.
A general rule of thumb is three or more hard credit checks in a three-month period will have a negative impact on your credit score.
There are exceptions to this. For example, if your phone contract expires and you renew it, this will have a positive impact on your credit score if you have made payments on time and cleared the existing debt. In short, any damage done by the hard credit check is offset by the positive action of managing your previous financial account correctly.
How Do Hard Credit Checks Impact Your Credit Score?
Lenders will also be able to see if you have multiple hard credit checks on your file when they assess whether to lend money to you.
You may have a good credit score but have multiple hard credit checks on your file in a short period of time. This signals a problem to lenders as they will want to know why you are so desperate for finance suddenly. Of course, the assumption would be you are struggling to make ends meet.
This is why you can be declined for finance even if your credit score is excellent due to too many credit checks on your file. Most mortgage lenders for example have a cutoff of three hard credit checks and will decline your application regardless of your credit score.
What is a Soft Credit Check?
Soft credit checks do not leave a visible mark on your credit profile. You might consider them as ghosts because other lenders will not be able to see these soft credit checks. As a result, soft credit checks do not have any impact on your overall credit score and will not result in further applications being declined.
Soft credit checks are not entirely invisible as both you and your credit reference agency will be able to access this information. For all intents and purposes though, this is purely information and there is nothing actionable about a soft credit check.
Lenders will normally conduct a soft credit check before an application for finance as a pre-approval. It saves customers time and hassle because they will know how likely they are to secure finance before making an application.
In rarer cases, lenders may use soft credit checks to approve an application. This is normally done as a marketing technique to attract more applicants. It is far less risky for a customer to apply for a credit card with a soft credit check than a hard credit check.
Bad Credit and Credit Checks
If you have bad credit or an adverse credit score, you will find the range of financial products available to you is limited. If you manage to secure finance, it typically costs much more because of the higher interest rates.
It is a good practice to avoid using hard credit checks wherever possible. Either by using soft credit checks to be pre-approved for finance or approaching companies that use soft credit checks on their finance applications.
Understanding How to Source Finance with Minimal Credit Score Impact
Be careful when searching online for bad credit finance as many companies advertise soft credit checks but conduct hard credit checks when you make an application. If you are approaching separate companies trying to secure finance, you may find the amount of hard checks appearing on your profile racks up.
A great alternative is the first bad credit comparison site that has been launched in the UK. When you search for finance a soft credit check is conducted and the results only show products you are likely to be approved for. You can then compare the interest rates and terms available before making an informed financial decision.