Welcome back to our new blog series, where we answer the questions you’ve been asking. This week, we’ve seen a lot of discussion on social media and in the news about credit scores, so we wanted to clear a few things up and explain exactly what is a credit score, how our products use them, what that means for you, and what the future might hold.
So this week, the burning question on your lips was “does Klarna impact my credit score?”
Let’s start at the beginning, before we get to what happens when you use Klarna, we need to start with the terminology.
What is a credit reference agency?
The foundations of credit scores, all start with a Credit Reference Agency (CRA). These agencies are sometimes referred to by a variety of names, so you may see them also called a ‘Credit Bureau’ or a ‘Credit Reporting Agency’ (to name a few).
A CRA is a company that gathers account information regularly from various financial providers such as banks, telephone companies, utilities etc. They also collect public information such as electoral rolls and bankruptcies. The agency then collates this information into one place for each individual, and shares it with UK lenders to help inform their lending decision process.
What is a credit score?
Before we get to what happens when you use Klarna, what actually is a credit score?
A credit score is a number based on a person’s credit information that represents the creditworthiness of that person. The higher the score, the better the expectation is that the person can be trusted to pay off their debts.
Each of the CRA’s have their own methodologies to calculate a credit score, which is based upon the data they have stored on that person. This means you will have a different credit score at each of the credit agencies (based upon the data they have available and also their own methodology to calculate your creditworthiness).
Credit scores are typically created using information on individuals such as how much you owe, how often you apply for credit, and whether your payments are made on time.
Lenders utilise one or more of the credit scores as part of their own credit assessments for individuals, and may also create their own versions of credit score adding in additional factors that they review.
There are a large number of applications that you can use to check your credit score, many of which are free, but it is important to remember that each of the CRA’s will have a different score, and each application will work with a different agency, therefore it is not unusual to see discrepancies across different applications. You can also request a copy of your credit score (and wider credit report) from any of the main credit reference agencies to understand your own credit profile.
If you’d like further information on credit scores, you can find out more here.
What is a credit search?
When you apply for a credit product, to decide if the product is suitable for you and if you are eligible, you will often have a ‘credit search’ or ‘credit check’ run to verify your personal details. You will probably have seen these mentioned when you’ve purchased a new mobile phone contract, when you have opened a bank account, or when you’ve used Klarna.
A credit search is where the lender (or comparison site), provides your personal details to one (or more) of the CRA’s, and the CRA returns the information they have matched to you. The information will include the credit score they have created for you, alongside the credit and public information that is on your file.
There are two types of credit searches that you might experience, a ‘soft credit search’ or a ‘hard (full) credit search’. Both types of searches return the same information from the credit agencies to the lender. So what’s the difference?
- Soft credit search – A soft credit search is used as part of an eligibility check. This search is not recorded on your credit file and therefore does not impact your credit score and it is not visible to other lenders. Whilst other lenders cannot see that a lender has run this soft credit check, you will be able to see this on your own file (so don’t worry, this is normal).
- Hard (or full) credit search – A hard credit search is completed when you proceed with a full credit application for regulated credit products, like a long term financing agreement or higher value loan such as a mortgage. This search is recorded by the CRA, and can be seen on your credit file. It may therefore impact your credit score and is also visible to other lenders. Too many hard credit searches in a short period of time can have a negative impact on your credit score.
Does using Klarna impact my credit score?
In the UK, Klarna offers three main products:
- Pay in 30 days
Pay in 30 days & Instalments.
For our two most popular products, Pay in 30 days and Instalments we perform soft credit searches to determine eligibility for every transaction.
From the 1st of June, 2022 Klarna will begin sharing Buy Now Pay Later purchases made in the UK with the credit reference agencies (CRAs) Experian and TransUnion. This means purchases you make on or after 1 June using Klarna Pay in 30, Pay in 3, in-app shopping and Klarna Card will become visible on your credit reports held by Experian and TransUnion. Consumers will no longer need to depend on using high interest and fee-charging credit cards to build a positive credit profile!
Initially, the Buy Now Pay Later purchases will not be taken into account when calculating credit scores but both Experian and Transunion are working to address this. We understand from that this may take 12 – 18 months.
However, while credit scores will not initially be impacted, BNPL purchases will be visible to other lenders and so may impact consumers’ ability to access credit.
For our longer term credit product, Financing (used for purchases like electronics and homeware from 6-36 months), we perform a hard credit search if you pass our initial eligibility checks. Our Financing product is a regulated credit product, used for higher value purchases, and is similar to other traditional finance providers where during application, you must sign a regulated credit agreement. This hard credit search can impact your credit score and is visible to other lenders.
When you have used Financing, Klarna reports to the CRA (the same as all other lenders for regulated products) on a monthly basis regarding the individual’s outstanding amount, any missed payments or special arrangements. If you pay off the outstanding amount as expected, this typically provides a positive impact on your credit score. However, if you do miss any payments this will impact your credit score negatively. This is all explained as part of the application process, and you can find more details and an example credit agreement here.