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How Does A Credit Application Work?

A credit application works through several steps. The first step is for the borrower to fill out the credit application form and provide the necessary information. The necessary information usually includes the borrower’s address, phone number, Social Security Number (SSN), employment, and salary. The information provided on the credit application form makes it easy for the lender to forward the contract to the collections agency or pursue legal action in case the borrower defaults on the loan or credit card payment.

The next step is for the lender to pull the borrower’s credit report. The borrower’s credit report contains relevant information, such as credit score and credit history. The lender also checks the income of the borrower to determine the debt-to-income ratio. The debt-to-income ratio measures the percentage of a person’s income that goes to credit or loan payments.

The next step is for the lender to do the underwriting process. The underwriting process determines whether the lender wants to approve the loan or credit based on the information gathered from the borrower and the credit report.

The last step is for the lender to inform the borrower of the decision. The decision to approve or deny a loan or credit application is easier and faster because of technology and the proliferation of online lenders. If the credit application is rejected, the lender must provide in writing the reasons why and the name and address of the credit bureau that provided the report, according to the Federal Trade Commission. The Federal Trade Commission helps consumers recognize and recover from unfair business practices and scams.

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What Is Information Needed For A Credit Application?

There are several pieces of information needed for a credit application. Here are the following:

• Address
• Phone Number
• Social Security Number (SSN)
• Employee Identification Number (EIN)
• Business Structure (for corporations, companies, partnerships, etc.)
• Credit References

This information must be accompanied by at least two forms of identintifaction to verify the applicant’s identity, such as a birth certificate, certificate of citizenship, driver's license, passport, social security card, or state-issued ID. Income verification may also be required through the following documents, such as paystubs, tax returns, W-2s & 1099s, bank statements, employment certificates, and income tax returns. For proof of address, there are several documents to choose from, such as utility bills, lease or rental agreements, mortgage statements, proof of insurance, voter registration cards, property tax receipts, and bank or credit card statements.

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Does A Credit Application Hurt Your Credit?

Yes, a credit application does hurt your credit score. New credit applications can hurt your credit in several ways, according to Fair Isaac Corporation (FICO). The first way is the hard inquiry. A hard inquiry is where the lender pulls out your credit report from one of the three major credit bureaus, such as Experian, Equifax, and TransUnion. The credit report from the three major credit bureaus can affect the score slightly compared to a soft inquiry. A soft inquiry does not affect the credit score.

New credit applications are 10% of a FICO® Score. FICO® Scores consider new credit applications in the last 12 months, while credit reports keep new credit inquiries for two years. Frequent new credit applications or opening several new credit accounts too frequently means a greater risk for lenders because they may think you are undergoing financial stress. Having too many new credit applications may hurt your credit score, according to Fair Isaac Corporation (FICO). FICO also states that the FICO® Scores are designed to only consider inquiries that impact credit risk. Inquiries pertaining to rate shopping are usually counted as one inquiry.

The next way a credit application can hurt your credit is through the length of your credit history. The length of your credit history consists of your oldest account plus the average of all other accounts. A new credit application lowers the average of your total accounts. A lower average of credit accounts means a lower length of credit history. A lower length of credit history eventually decreases your credit score.

Another way a credit application can hurt your credit is through the amounts owed. The amounts owed include the credit utilization ratio. The credit utilization ratio compares your credit balances to your credit limits. Typically, a lower credit utilization ratio means a higher credit score. A new credit application increases the credit limit but also increases the credit balance when you use it, so the credit utilization ratio can increase. An increase in the credit utilization ratio can lower your credit score.

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How Does A Credit Application Protect A Buyer And Seller?

A credit application protects a buyer and seller through a letter of credit. A letter of credit is a bank document that guarantees payment to the seller if the buyer fails to pay. A letter of credit gives added security to a buyer and a seller when making transactions for products or services, especially if the buyer and seller are from different countries.

Buyers are protected by letters of credit. A standby letter of credit is similar to a refund that is paid back to the buyer if the seller fails to provide or deliver the product or service. The buyer can use the money to pay another seller to provide the product or service needed.

Sellers are protected by letters of credit. The letter of credit serves as insurance if the buyer fails to pay a seller. The bank that issued the letter of credit must provide payment to the seller as long as the seller fulfills all the requirements in the letter.

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How Long Is A Credit Application Good For?

A credit application is good for 90 days which is why it is better to wait for the said duration between new credit applications. Waiting for 90 days up to 6 months between new credit applications helps in protecting the credit score from the negative impacts of too many credit inquiries in a short period of time.

Credit applications are kept in the credit report for two years, while FICO® Scores only consider credit applications in the last 12 months.

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