Credit Score Explained

Summary

This video from Practical Personal Finance educates viewers on credit scores, their history, and significance in lending decisions. It covers the FICO and Vantage scoring systems, explaining how they're derived from credit reports by Equifax, TransUnion, and Experian. The video outlines the factors influencing credit scores: payment history, amounts owed, credit history length, credit mix, and new credit inquiries. It concludes with a tip for boosting one's score by becoming an authorized user on a family member's credit card account.

Takeaways

• 😀 A credit score is a numerical representation that helps banks and lenders quickly assess the likelihood of you repaying borrowed money on time and in full.
• 🏦 Before credit scores, lending was based on personal relationships and reputation, which provided assurance to banks that borrowers would not default.
• 📊 Your credit score is derived from your credit history, which is a record of your repayment behavior on loans over the past 5 to 7 years, maintained by credit bureaus like Equifax, TransUnion, and Experian.
• 💯 The FICO and Vantage scores are two well-known types of credit scores, which are based on the same credit report information but may differ slightly due to varying analysis methods.
• 🚫 Having a credit score of zero isn't necessarily bad; it means you're not currently incurring debt. However, maintaining at least one account can facilitate future borrowing.
• 📈 A good credit score is generally considered to be above 650, with scores above 750 indicating excellent credit health.
• 💳 Payment history is the most significant factor in your credit score, accounting for about a third of the score, and reflects your timeliness in bill payments.
• 💳 Amounts owed is also crucial, representing about a third of your score, and considers the percentage of your loan paid off and credit card limit utilization.
• 🗓 The length of your credit history contributes to about 15% of your score, focusing on the age of your active accounts.
• 🔄 Credit mix and new credit inquiries each account for about 10% of your score, with a diverse credit portfolio and limited new credit applications being favorable.
• 🤫 A secret to boosting your credit score is to become an authorized user on a close friend or family member's credit card account, which can positively impact your credit mix, history, and utilization.

Q & A

What is the purpose of a credit score?

A credit score is a numerical representation used by banks and other lenders to quickly assess the likelihood that a person will repay borrowed money on time and in full.

How has the process of lending money changed since the advent of credit scores?

Before credit scores, lending was more difficult and relied heavily on personal relationships between bankers and clients. Credit scores have simplified the process by providing a standardized measure of creditworthiness.

What are the two most popular types of credit scores mentioned in the script?

The two most popular types of credit scores mentioned are the FICO score and the VantageScore.

What are the three credit bureaus that maintain credit history?

The three independent credit bureaus that maintain credit history are Equifax, TransUnion, and Experian.

What is the highest and lowest possible credit score?

The highest credit score one can achieve is 850, and the lowest is 300. A score of zero indicates no active accounts and no debt.

What is the significance of maintaining at least one credit card account open?

Maintaining at least one credit card account open helps to establish a credit history, which can make it easier to obtain loans in the future and maintain a good credit score.

What is the threshold for a 'good' credit score according to the script?

A credit score above 650 is considered good, while a score above 750 indicates excellent credit.

What are the five factors that influence a credit score?

The five factors influencing a credit score are payment history, amounts owed, length of credit history, credit mix, and new credit.

Why is payment history considered the most important factor in credit scoring?

Payment history is the most important factor because it accounts for about a third of the credit score and reflects a person's track record of paying bills on time, which is crucial for lenders assessing the risk of lending.

How can becoming an authorized user on someone else's credit card account help improve one's own credit score?

Becoming an authorized user can improve one's credit score by potentially increasing credit mix, length of credit history, and reducing credit card utilization percentage, provided the primary account holder has a good credit history.