If you’re wondering why do credit checks lower credit scores, you’re not alone. Nearly two-thirds of Aussies don’t even know their credit score and 1 in 7 Aussies are too scared to check. New research also suggests that 50% of Aussies surveyed don’t know how and where to check their credit score.
It’s fair to say a lot of us are at a bit of a loss when it comes to the question “why do credit checks lower credit scores”. In fact, there is a large gap between what a credit score really is, and the public perception of what having a credit check does and does not mean. So, how do we close the gap?
The best place to start when fighting misconceptions, is with the facts! So, we’ve answered a few common questions to help you get acquainted with your credit score and why having a credit check might lower your credit score.
No! Checking your credit score yourself does not damage your credit file. Surprised? You’re not the only one. It’s a common myth, as 19% of Aussies believe that checking on their credit score will hurt their file. As an individual checking your credit score, you can breathe a sigh of relief – you’re in the clear. Not only is your credit score safe, but so is your wallet, as most basic credit checks come free of charge.
If third-parties, such as lenders, conduct check credits, however, the story can be a little different. Lenders conducting credit checks could mark your file with a hard enquiry, leaving a minor impact on your credit file. This is where the question “why do credit checks lower credit scores” is so common.
Several factors make up your credit score, each weighted differently depending on their significance. The next step in getting to know your credit score is uncovering what makes it tick. The key to maintaining a healthy credit score is understanding how different financial decisions impact your score. Take a look at the 5 factors that affect your credit score:
Weighing in at number 1 is bill payment history. The quality of your payment history determines 35% of your credit score. So, what does it mean to have a pristine payment history? Mostly, it’s the little stuff. Such as paying bills on time and making timely repayments on credit cards and loans. The biggest favour you can do your credit score is making your payments on time each month. It’s a win-win – avoid nasty late fees and keep your credit score fresh! Your future self will probably thank you.
Debt level attributes to 30% of your credit score. Credit score agencies, such as Equifax and Experian, analyse particular factors of your debt to calculate your credit score. These include, but are not limited to, your total debt amount, the ratio of credit card balances to your credit limit (also known as credit utilisation) and the correlation of a loan balance to the original loan amount.
As a general rule, it’s good practice to maintain credit utilisation at 30% or less. In other words, only charge up to 30% of any available credit on your card. Much like bill payment history, losing control of debt can significantly damage your credit score. The good news? It works both ways. If you work to pay off your debt, you can drastically improve the health of your score. What a bonus!
When it comes to credit checks, age matters. The age of your credit history accounts for 15% of your credit score. Age demonstrates experience. Therefore, the older your credit history, the stronger your credit score. Don’t shy away from the odd wrinkle or frown line, as it highlights how you handle credit. Opening and closing accounts can alter your average credit age, so keep accounts open, even if you no longer use them – provided they’re paid for, of course.
Age without diversity holds little purpose. So, while your credit history ages, it’s important to remember to diversify your credit. Your credit history should show two basic types of credit accounts: revolving accounts and instalment loans. A revolving account is an account that can incur debt where the borrower is not obligated to repay the outstanding balance each month. An instalment loan is a loan that you must repay over a set period, such as a car loan or mortgage.
To really hit peak diversity on your credit file, you could take out different loans for a variety of assets, such as a car or a home, as well as credit cards and personal loans. Credit diversity only accounts for 10% of your score, so it’s more beneficial to focus on bill payments and to repay lingering debt.
Credit enquiries make up 10% of your credit score. Conducting your own credit check won’t reflect negatively on your credit score. However, if you submit a loan application, you will incur an enquiry on your credit report. This enquiry simply demonstrates that you’ve made a credit-based application.
The average Australian will typically have a few credit enquiries on their report – it’s expected, especially given how we all shop around to find the best possible rates and offers. However, several enquiries, especially during a short period, will negatively impact the health of your score. So, keep that in mind when you’re looking to borrow money, or take out a new credit card.
Your credit score contains a variety of intricacies and different types of enquiries have varying levels of impact. Credit enquiries are classified into two categories; hard enquiries and soft enquiries. The critical difference is that a soft enquiry does not negatively affect your credit score health; however, a hard enquiry certainly will. For example, if you decide to take out a personal loan the lender will conduct a credit check, leaving a hard enquiry on your credit report.
As an individual, you may not be penalised for conducting your own ‘credit check’. Submitting a request to review your credit score registers as a soft enquiry and has no effect on your score. Soft enquiries are only visible to you on your personal credit report. It’s perfectly normal to see several soft enquiries on your credit report. In fact, it’s good to become familiar with the notes on your report so you can see what does and doesn’t affect your credit score.
When we venture into hard enquiries, things become a little more grey. A hard enquiry will occur when you authorise a third-party, such as a lender or credit card issuer, to review your credit report. The penalty for a hard enquiry varies, however, according to FICO you may only incur a 5 to 10 point drop per enquiry. Even though hard enquiries are pinned to your credit report for 2 years, they may only impact your score for a few months.
The essential difference between a hard and soft enquiry lies in whether you give the lender permission to check your credit. To help you identify hard and soft enquiries on your credit report, here are a few examples.
Other types of credit checks may be classified as either a hard or soft enquiry, including an insurance company enquiry, or a credit check conducted by your cable or internet providers.
So why do credit checks lower credit scores? When you apply for finance, it is signalling to potential lenders and credit providers that you’re in need of finance. Whilst a single application shouldn’t do too much harm to your credit rating, multiple hard enquiries on your report can do some real damage. Why is this? Because it indicated to credit providers that you are in financial distress and desperately trying to get extra finance. This is the message it sends to lenders regardless of whether it’s the truth.
If you have too many credit applications on your report in close succession, this could also lead to lenders rejecting your loan application, which could further harm your score. That’s why it’s a good idea to space out your credit applications, so lenders and credit providers don’t get the impression that you’re in a bad financial situation.
Borrowing money for that first family home, or your dream car is a part of life. Don’t shy away from applying for finance you need just to avoid a hard enquiry on your credit report. There are a few ways you could minimise the impact of hard enquiries.
Firstly, don’t let the fear of a hard enquiry stop you from browsing interest rates when shopping for a home or car loan. Some credit score providers, such as FICO, allow for a 30-day cooling-off period before specific loan enquiries are reflected on your credit score. Credit providers may also combine similar loan enquiries into a single enquiry on your credit report. This will lessen its effect on your score, as long as they were made within a certain window.
So, when hunting down the best loan, don’t settle for the first one you see. Set a designated window to shop without the worry of it severely affecting your credit score.
Now you know the answer to “why do credit checks lower credit scores”, and you have the tools to limit the damage, you can go fourth and use this information for the good of your credit rating.
A credit score demonstrates to lenders your ability to repay your loan and can also reveal the likelihood of incurring an adverse event in the following months. A bad credit score is typically anything below 509.
An Equifax or Experian score is the most common way to measure your credit score. The score ranges from 0 to 1200, 0 being the worst and 1200 is perfect. So, you’ve requested your credit score, and now you have your number, but what does it actually mean? Good question. Below is a handy breakdown of what your score indicates:
|Score||What it means|
|Below average to average (0-509)||It’s more likely that you may incur an adverse event, such as a default, bankruptcy or court judgement in the following 12 months|
|Average (510-621)||You may likely incur an adverse event, such as a default, bankruptcy or court judgement in the following 12 months|
|Good (622-725)||It’s less likely that you may incur an adverse event that could damage your credit file in the following 12 months|
|Very good (726-832)||It’s unlikely that you may incur an adverse event that could damage your credit file in the following 12 months|
|Excellent (833-1200)||It’s highly unlikely that you could incur an adverse event that could damage your credit file in the following 12 months|
By jumping online and submitting a few details, you can generally check your credit score for free. There is a myriad of sites that will deliver a bog-standard credit score calculation from a single credit reporting agency.
Credit scores are vital for understanding your overall financial health and assessing your suitability for credit approval. So, we think you deserve the big picture, not just a single frame. We believe it’s time you meet Tippla.
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While we at Tippla will always do our best to provide you with the information you need to financially thrive, it’s important to note that we’re not debt counsellors, nor do we provide financial advice. Be sure to speak to your financial services professional before making any decisions.