Are credit checks mandatory for credit cards?

Your credit score is an indication of your creditworthiness and ability to responsibly service repayments on credit products and utility bills. It is one of the metrics used by credit providers, like banks, credit card issuers and lenders, to assess your likelihood to meet your repayments.

A credit check, also known as a credit inquiry or credit assessment, is a process performed by lenders, banks, or financial institutions to evaluate an individual's creditworthiness and financial history. It involves accessing and reviewing the individual's credit report and credit score to assess their ability to manage and repay debts

When you make an application for any kind of credit, such as a credit card or a home loan, the lender must carry out a mandatory credit check to view your credit score and financial history. This kind of a credit check is also called a hard credit check, and it allows lenders to make informed decisions about whether to approve a credit application and on what terms to offer the loan. A hard credit check will reflect on your credit history, and it will be visible to prospective lenders when you apply for any credit product down the line. 

But it’s not just lenders. Even you can check your credit score before making a credit application to better understand how lenders might perceive your application. Don’t worry, this is not the same as a hard credit check, and it won’t appear on your credit report or affect your credit score in any way.

Types of mandatory credit checks

There are two types of mandatory credit checks:

• Hard credit check – a ‘hard’ credit check or credit inquiry involves a credit provider assessing your credit file and credit score to determine your creditworthiness. A hard credit check will be reflected on your credit history.

• Soft credit check – a ‘soft’ credit check or credit inquiry is one in which a credit provider will gain access to your credit score, without this action being reflected in your credit history.

Credit cards will typically always require a hard credit check into your credit file. While this may or may not affect your credit score, what we do know is that multiple hard credit checks at one time can hurt your credit score. Applying for multiple credit cards at once to ‘hedge your bets’ can have the opposite effect in terms of credit approval, as it may make you appear credit hungry.

However, there are situations where lenders may conduct soft credit checks, particularly during pre-approval processes such as when applying for an instant approval credit card. With "instant" approval, the lender typically provides an indication of your eligibility within 60 seconds of receiving your application, based on a soft credit check.

The idea of no credit checks is typically limited to ‘payday loans’, which are sometimes used as short-term solutions for cash-strapped Australians. They carry a range of risks, including putting individuals into a worsened cycle of debt due to higher than average fees. Additionally, some Buy Now, Pay Later (BNPL) platforms have gained popularity in recent times by giving consumers access to credit without performing hard credit checks. Major providers, like Afterpay, offer customers a credit limit, but do not perform hard credit checks on customers.  However, if you have consistent poor payment behaviour, Afterpay may reserve the right to report payment defaults to a credit reporting bureau.

It's important to be aware that the landscape for BNPL services is expected to change in the near future. Australia’s Federal Government is taking steps to increase regulation of the BNPL sector. According to a recent announcement, it is expected that by the end of 2023, BNPL services will be considered as consumer credit products under new laws. 

Under the new regulations, BNPL companies will need to comply with Responsible Lending Obligations and hold Australian Credit Licences. Therefore, it is possible that signing up for Afterpay or similar Buy Now, Pay Later (BNPL) services in the future may necessitate a credit check.

Regardless of whether you opt for a credit card or a BNPL option, poor payment behaviour will always increase your risk of damaging your credit score and credit file.

Financial providers perform credit checks to determine your credit-worthiness. This is to protect themselves as well as you. They want to provide financial products to individuals who are likely to pay their bills and not overdraw their accounts. Lenders also don’t want you to fall into debt and negatively affect your credit score, as well as your livelihood.

This is where credit scores come into play. According to ASIC’s MoneySmart website, the position of your credit score on this scale “helps lenders work out how risky it is for them to lend to you:

• Excellent – you are highly unlikely to have any adverse events harming your credit score in the next 12 months;

• Very good – you are unlikely to have an adverse event in the next 12 months;

• Good – you are less likely to experience an adverse event on your credit report in the next year;

• Average – you are likely to experience an adverse event in the next year; and

• Below average – you are more likely to have an adverse event being listed on your credit report in the next year.”

Applying for a credit card always involves a mandatory credit check. This is an essential part of testing your ability to responsibly service your repayments and is done in your best interest. 

It means every time you apply for a credit card (or any financial product) the lender will perform a ‘hard’ inquiry on your credit report. If you are rejected, this may negatively affect your credit score and show up on your credit history for up to 12 months. 

If you already have an average credit score, getting rejected for a credit card could make your financial history look worse. To help improve your chance of approval and decrease your risk of negatively affecting your credit score, you could utilise comparison tools to find credit cards that suit your financial situation, i.e., targeted to low income earners, people with bad credit, etc.

RateCity’s credit card comparison table allows you to search, filter and compare competitive credit card options that suit people with different financial requirements. Use this tool to search through credit card interest rates, as well as read product reviews, who the credit cards are suitable for and what minimum income requirements could be.

If you’re considering taking out any credit product, it may be worth assessing your own credit score and ensuring it is where you think it is. If your credit score is below average, or if you just want to help improve it, there are steps you may take: 

Get a copy of your credit scores 

RateCity allows you to see your credit scores from major bureaus, Equifax and Experian, for free. This process involves a soft credit check, so should not affect your credit file.

Look through your credit file for errors 

You may wish to go deeper into your credit history. The major reporting bureaus are legally required to offer you access to your credit file for free once every three months. Once you have a copy of your file, go through it with a fine-tooth comb and search for any errors. This is not uncommon, so it’s worth doing your due diligence.

Pay down your debts  

If you have existing debts, such as a personal loan or a maxed out credit card, it may be worth paying these off before you apply for a new credit card. Paying off your debts can have a positive impact on your credit history, and potentially improve your credit score.

Make payments on time 

Set reminders or direct debits for any ongoing payments, such as your mortgage repayments, phone bill or utilities payments. Making payments on time, and avoiding late payment penalties, can make a positive impact on your credit score.

Check your eligibility for the card

Card providers often have specific eligibility criteria for different card types. It’s important for you to ensure that you meet the eligibility criteria before applying to avoid the possibility of your application being rejected. For example, many premium cards have minimum income requirements that must be met in order to qualify. These minimum income requirements typically range between $30,000 and $40,000 for standard and rewards credit cards, however low income credit cards can have minimum income requirements as low as $15,000 per year.

Obtaining a credit card with bad credit can be challenging, but it is still possible. Interestingly, there’s no universal definition of bad credit. Each lender will have their own criteria around bad credit classifications, and how this determines your eligibility and chance of approval. But keep in mind that having bad credit may limit your options and result in higher interest rates or fees. It is advisable to explore options specifically designed for individuals with bad credit or work on improving your credit score before applying for a credit card.

Besides, you may also want to reconsider your suitability for credit by understanding why you have bad credit in the first place. It’s possible you missed some repayments in the past or had difficulty managing your finances. However, since then, you have successfully taken steps to get your finances back on track. In that case, positive financial behaviours like paying your bills on time can help you improve your credit score over time. However, if you’re still struggling with finances and want to get a credit card to better manage your finances, you may want to reconsider your options. 

While a credit card can be a helpful tool to manage your spending and even earn rewards for it, it’s not a money management or budgeting tool that could help you with your financial woes. On the contrary, a credit card could make it easier to spend money that’s not your own, potentially making your problems worse.

If you’ve got bad credit and you find yourself in a dire financial situation, it may be wise to seek financial counselling before applying for any further loans or credit cards. To find your nearest financial counsellor, or for more information, please visit ASIC’s MoneySmart website.