Credit Scores

Red Flags and Red Herrings in Job Applicants' Credit Reports

Red Flags and Red Herrings in Job Applicants' Credit Reports
Image credit: Chris Potter | Flickr
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Regardless of the size of your staff, a company is only as good as the people who work for it. When you're looking for new members of your team, it makes sense to find the most capable and reliable people possible.

Related: Negotiating Secrets: How to Convince Creditors Not to Ruin Your Credit Score 

But how do you quantify responsibility? Since these traits are difficult to discern from resumes and cover letters, many hiring managers look to the applicant's credit history.

If your knowledge of consumer credit is a bit fuzzy, don't worry -- a majority of Americans have a tenuous understanding of their credit. This article will show you how to find an applicant's credit report, what's in it and what you should be looking for during the hiring process.

How to pull an applicant's credit report

First, you want to see an applicant's credit report, not his or her credit score. A credit score is a three-digit number derived from the information in someone's reports from the three major credit bureaus (TransUnion, Experian and Equifax), and is usually calculated through a proprietary algorithm.

A credit score may tell you someone has bad credit, but it won't explain how it happened. This is an important distinction because a bad credit score is not always the result of irresponsible financial habits.

When you're ready to pull the applicant's credit report, you'll need his or her written consent (as mandated by the Fair Credit Reporting Act).

Next, simply notify one of the three major credit reporting bureaus that you're acquiring someone's credit report for business purposes. Experian, for example, has a page dedicated to pulling credit reports on other people. Or, you could contact third-party groups such as StarPoint or ADP to perform credit checks on employees.

Related: How to Fix Mistakes on Your Credit Report

Alternatively, you could do a "proxy order" by having the applicant request his or her own credit report and hand it over to you. People can do this for free once a year for each bureau via www.annualcreditreport.com

What you'll see in a credit report

The credit report will contain:

  • Basic information about the applicant (name, address, etc.)
  • Past and present lines of credit, such as mortgages, student loans, personal loans, credit cards and more. These sections will include the accounts' status, their history of payments, current balances and additional details
  • A list of recent credit inquiries, including the date, the business involved and the reason for the credit inquiry
  • Public records, which typically include court judgments such as tax liens and civil actions
  • History of bankruptcy.

To get an idea of what kind of credit report you'd receive, check out this example from Experian.

Red flags

When you're trying to assess whether this potential new employee has reliability issues, it's best to examine his or her credit report from a long-term perspective. Some of the most telling details will be in the public records sections. If someone's personal finances have deteriorated to the point that a court had to get involved, that may be a sign of reoccuring fiscal irresponsibility.

True, a consumer may file for bankruptcy after an unexpected event such as a medical emergency, but many times he or she will file after becoming trapped in cyclical debt or through excessive spending.

Likewise, a series of missed payments may indicate that the applicant has had difficulty meeting deadlines. Tax liens and mortgage defaults are also things that tend not to happen overnight, meaning the applicant had ample time to try to correct the situation.

Red herrings

"Red herring," a literary term, means a detail or event that seems noteworthy at first glance but ultimately turns out to be unimportant. When it comes to credit reports, there are plenty of red herrings.

Consumer-credit risk analysis is a notoriously fickle science. For example, a single missed payment on a credit card is enough to drop someone from an "excellent" credit score to "fair" or worse. Medical debts are also worth careful consideration, considering the fact that those debts frequently overpenalize consumers and contain errors.

The message here is that a single missed payment in an otherwise flawless history of repayment shouldn't be cause for alarm, even if the individual's credit score took a significant hit for it. 

Frequent credit checks, too, are another cause for credit-score penalties. If the consumer has an otherwise healthy profile and keeps his or her debt utilization ratios at safe levels, it's entirely possible that what's happening is "churning" of credit cards just for the rewards. This may indicate that someone is a savvy consumer, as opposed to a spendthrift.

Many millennials will likely have large installment loans on their credit reports, often upwards of five figures or more. In many cases, these are student loans, not reckless borrowing.

In addition, many negative marks will stay on credit reports for a long time, often either seven or 10 years after the penalty first appeared on the report. It's entirely possible that, within that time, the applicant has learned from his or her mistakes.

Additional considerations

In the event you decide not to hire someone based on the contents of a credit report, you will need to send this person a pre-adverse action disclosure. This is how you, as an employer, will let the applicant know of the denial of employment due to the contents of a credit report. 

The pre-adverse action disclosure must include both a copy of the credit report you received and a Federal Trade Commission document titled "A Summary of Your Rights Under the Fair Credit Reporting Act."

You should also ask the applicant whether he or she has reviewed the credit report recently for errors. According to the FTC, one in four consumers have errors on their credit reports.

If the applicant seems otherwise perfect for the open position, ask for an explanation of the negative marks on the credit report. Not only will you learn more about this individual's financial history but gain valuable insight into how he or she addresses and recovers from setbacks.

Related: 9 Strategies for Improving Your Credit Rating