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.

Outlines

00:00

💼 Introduction to Credit Scores

This paragraph introduces the concept of credit scores and their importance in personal finance. It outlines the video's structure, which will cover the history of credit scores, different types of scores, what makes a good score, and factors influencing credit scores. The speaker uses an analogy of lending money to a friend versus a stranger to explain the role of credit scores in lending decisions. Credit scores have replaced personal relationships as the primary factor for banks to determine loan eligibility. The video promises to reveal a secret to achieving a high credit score with minimal effort by the end.

05:01

📊 Understanding Credit Scores and Their Types

The speaker explains that credit scores are numbers based on an individual's credit history, maintained by credit bureaus like Equifax, TransUnion, and Experian. These scores help banks assess the likelihood of repayment. The paragraph discusses the FICO and Vantage scores, which are popular types of credit scores that may vary slightly due to different analytical methods. The video mentions that the highest possible credit score is 850, and a score of zero indicates no active debt, which isn't necessarily bad but can make borrowing difficult. The speaker suggests maintaining at least one account to keep the credit score active.

10:02

💳 Factors Influencing Credit Scores

This section details the five key factors that affect credit scores: payment history, amounts owed, length of credit history, credit mix, and new credit. Payment history, accounting for about 33% of the score, is crucial as it reflects bill payment punctuality. Amounts owed, also significant, considers the percentage of long-term loans paid and credit card limit usage. Length of credit history, about 16% of the score, is based on the age of active accounts. Credit mix, around 10%, favors a variety of active accounts. Lastly, new credit, also 10%, is influenced by the frequency of credit inquiries. The paragraph concludes with a teaser for a secret to boost credit scores, encouraging viewers to watch till the end.

🔑 The Secret to Boosting Your Credit Score

The final paragraph reveals a secret to improving credit scores: becoming an authorized user on a close friend or family member's credit card account. This can positively impact the credit score by increasing credit mix, length of credit history, and reducing credit card utilization percentage. The speaker invites viewers to ask questions in the comments and encourages subscribing for more financial advice, thanking them for watching.

Keywords

💡Credit Score

A credit score is a numerical representation of an individual's creditworthiness, which is used by banks and other lenders to assess the likelihood that the person will repay borrowed money. In the video, credit scores are depicted as a crucial tool for lenders to quickly determine the risk associated with lending money to an individual, as it encapsulates their credit history over the past five to seven years. The video emphasizes the importance of a good credit score for securing loans on favorable terms.

💡Credit Bureaus

Credit bureaus are agencies that collect and maintain information about individuals' credit histories. Equifax, TransUnion, and Experian are the three major credit bureaus mentioned in the video. They play a pivotal role in the credit scoring process by maintaining records of an individual's borrowing and repayment history, which are then used to calculate credit scores. The video highlights how these bureaus' data forms the basis for lenders' decisions regarding loans.

💡FICO Score

The FICO score is one of the most widely used types of credit scores in the United States. It is calculated using a specific formula that considers various factors from an individual's credit report. The video explains that while all credit scores are based on the same information, different scoring models like FICO may analyze that information differently, leading to slight variations in scores. The FICO score is particularly important because it is often used by lenders to make lending decisions.

💡VantageScore

VantageScore is another type of credit score, developed as a joint effort by the three major credit bureaus. It is mentioned in the video as an alternative to the FICO score, with the key difference being the methodology used to calculate the score. The video suggests that both FICO and VantageScore have evolved over time, with improvements reflecting changes in how creditworthiness is assessed.

💡Payment History

Payment history is a critical component of a credit score, accounting for about one-third of the total score. It refers to the timeliness and regularity of an individual's payments on loans and credit cards. The video stresses that a flawless payment history is essential for a high credit score, as it demonstrates reliability and trustworthiness to lenders. Late or missed payments can significantly damage a credit score.

💡Amounts Owed

Amounts owed, which also account for approximately one-third of a credit score, refer to the total debt an individual has, including the balance on credit cards and the outstanding amount on installment loans. The video explains that a lower balance relative to the credit limit is preferable, as it indicates a responsible borrowing pattern and can positively impact the credit score.

💡Length of Credit History

The length of credit history represents the average age of all active credit accounts an individual has. As discussed in the video, this factor makes up about 15% of a credit score and is influenced by the age of loans and credit cards. The video points out that older accounts can contribute positively to the credit score, even if they are no longer in use, as they show a longer history of responsible credit management.

💡Credit Mix

Credit mix refers to the variety of credit accounts an individual has, such as credit cards, mortgages, and student loans. The video explains that a diverse credit mix can positively affect a credit score, as it shows the ability to manage different types of credit responsibly. Lenders view a varied credit portfolio as a sign of financial maturity and stability.

💡New Credit

New credit involves recent applications for new loans or credit cards, which can impact the credit score. The video notes that while inquiries for new credit can temporarily lower the score, they typically have a smaller impact if they are infrequent. The video advises caution in applying for too much new credit in a short period, as it can signal financial instability to lenders.

💡Authorized User

An authorized user is someone who is added to an existing credit account but does not have the primary responsibility for the account. The video suggests that becoming an authorized user on a close friend or family member's credit card account can improve one's credit score by increasing the credit mix, extending the credit history, and potentially reducing the credit utilization rate, provided the primary account holder has a good credit management history.

Highlights

Introduction to credit scores and their significance in financial management.

Historical context of lending before the existence of credit scores, relying on personal relationships.

Explanation of how credit scores serve as a quick assessment tool for banks to gauge loan repayment likelihood.

Description of the role of credit bureaus like Equifax, TransUnion, and Experian in maintaining credit histories.

Differentiation between FICO and Vantage credit scores and their calculation methodologies.

Range of credit scores from 300 to 850 and the implications of having a score of zero.

Advantages of maintaining a credit score and the suggestion to keep at least one account open.

Definition of a 'good' credit score and the thresholds for different credit score categories.

Instruction on how to check credit scores for free and a link provided for further guidance.

Importance of the five factors influencing credit scores: payment history, amounts owed, length of history, credit mix, and new credit.

Emphasis on payment history as the most critical factor, accounting for about a third of the credit score.

Discussion on amounts owed and its impact, focusing on loan payments and credit card utilization.

Impact of the length of credit history on the credit score and the significance of account age.

Credit mix and how having a variety of active accounts can positively influence the credit score.

The effect of new credit inquiries on the credit score and the strategy to manage them.

Secret tip for boosting credit scores by becoming an authorized user on someone else's credit card account.

Encouragement for viewers to ask questions and engage with the content for further understanding.

Transcripts

this is just about everything you need

to know

about credit scores

[Music]

hello and welcome to practical personal

finance where you get the information

you need

to understand and succeed with money if

you're new to credit scores or just want

to enhance your knowledge

then you're in the right place this

video is going to be broken up into

three parts in part one i'm going to

teach you about what credit scores are

and what life was like before they

existed then in part two

i'll tell you about the different types

of credit scores and what constitutes a

good score finally in part three we'll

finish up with the five factors that

influence

your credit score and for those of you

who stick around until the very end

i'll let you in on a little secret that

will help you achieve a high credit

score

with very little effort in a short

amount of time

let's get started

think of a close friend of yours someone

you've known for a long time

10 years or more now let's say that

person called you up and said

hey i need some cash to get some repairs

done on my car

could you spot me 500 i'll pay you back

next month

when i get paid with some interest if

you knew this person well enough

you probably have a sense of whether

you'll get your money back next month

or if lending the money is a bad idea

but imagine if the person

asking you to borrow money and promising

to pay it back with interest

wasn't someone you knew personally but a

stranger in front of you in line at the

grocery store

this is the position banks are in when

we ask them to borrow money

and yet a lot of times they let us

borrow the money anyway

without even really getting to know us

what makes them do that you ask

your credit score your credit score is a

way for a bank

or other lender to quickly ascertain how

likely you are to pay them back on time

and in full before credit scores existed

lending and borrowing money was much

more difficult

and it was largely based on personal

relationships between

bankers and their clients banks needed

assurance that you weren't going to take

their money and skip

town never to be seen again and your

reputation provided a big

portion of that assurance but now your

credit score precedes your reputation

and your personal relationships and is

the primary factor used to determine

whether or not

you get a loan and on what terms

your credit score is a number assigned

to you

based on your credit history i.e your

record with other loans over the past

five to seven years this record is

maintained by

three independent credit bureaus equifax

transunion and experian if you have a

perfect record

you'll end up with a high credit score

and you'll find it very

easy to borrow money with favorable

terms but if your record is flawed

you'll end up with a low credit score

and you'll probably find it difficult to

borrow money at all

[Music]

two of the most popular and well-known

types of credit scores

are the fico score and the vantage score

these scores are all based on the same

information that's included in your

credit report

with those three credit bureaus but the

scores may be slightly different based

on how they analyze that information

and how much weight they assign certain

factors

it's kind of like if you gave two chefs

the same ingredients

and told them both to make you some

chicken parm

the resulting dishes are both going to

be chicken parm

but they'll be slightly different in

addition to that

the fico score and vantage score have

both been refined

and improved over time and you might run

into

older versions still being used this is

especially true when you're applying for

a mortgage

but again it's just like if you gave a

chef a set of ingredients on two

separate occasions

five years apart and asked for chicken

parm

both times over time the chef's cooking

technique

changed and improved you're going to get

chicken parm on both

occasions but chances are it'll be a

little different and better

the second time the highest credit score

you can get is

850. the lowest credit score you can get

is 300. if you have no active accounts

on your credit report

your score will be zero having a credit

score of zero

isn't necessarily bad it just means

you're not currently participating by

incurring

debt some people believe that's a good

thing i personally believe

it's not a bad idea to maintain your

score by keeping at least

one account open as long as it's not

costing you anything to do so

this will make your life a heck of a lot

easier when you want to take out a loan

for that reason among others i have a

couple of credit card accounts open that

i pay in full

every week or two and i think you should

do the same

everyone and their mother seems to have

a different definition for what is

considered a good credit score

i like to keep things simple so if you

ask me anything higher than

650 means you're doing a good job

anything higher than 750

means you're doing a great job and

anything under 650

means you can use some improvement if

you would like to check what your credit

score is for free

i made a video on how to do it and i'll

leave a link down below

if your credit score could use a little

pick me up stick around until the end of

this video

and i'll let you in on a little secret

that's sure to help

last but not least let's talk about the

five factors that

influence your credit score they are

your payment history

amounts owed length of history

credit mix and new credit let's break

these out

one by one so you can begin to

understand what each of these factors

are

and how much influence they have on your

credit score

factor number one is your payment

history this one is the single

most important factor and it's

responsible for about a third of your

credit score

in short your payment history is all

about whether or not you pay your bills

on time

this includes things like student loans

mortgage payments

car payments and credit card payments

the main thing lenders want to know is

that you're going to pay them back

if you pay your bills on time every

month your payment history will be

flawless

if you're late even once your credit

score is going to take a big hit

more than once you're in the toilet late

payments will stick around on your

credit report and

ding your credit score for up to seven

years

factor number two is your amounts owed

this is a close second for the most

important factor

and again it's responsible for about a

third of your credit score

with amounts owed we're primarily

looking at the percentage paid on your

long-term loans

and the percentage of your credit card

limit that you're using on a monthly

basis

for long-term debt like student loans or

car loans

a higher percentage of the total loan

paid indicates that you're a reliable

borrower

for example if you have a student loan

you've been working on for six years and

it's eighty percent paid off

that's good but if you just financed a

brand new bmw five series with

zero dollars down and haven't made a

single payment yet

that's bad both for your credit score

and your net worth

please don't go out and finance a 5

series with credit cards

you want to use only a small percentage

of your monthly limit

the smaller the better so for example

let's say you had a discover

card with a one thousand dollar limit if

the balance on your statement is one

hundred dollars

you're in good shape but if the balance

on your statement is eight hundred and

fifty dollars

your credit score is going to take a hit

factor number three is the length of

your credit history

this one is responsible for about 1 6 of

your credit score

plain and simple the length of your

credit history is all about the amount

of time you've had your different

accounts

active if you took out a student loan 12

years ago

that account is 12 years old even if you

didn't make a payment on it while you

were still in school

if you got a new credit card six years

ago and you've kept it active

that account is six years old your

credit score looks at the average age of

all your active accounts

once a student loan or other installment

loan is paid in full

it no longer counts toward the length of

your credit history

if it was an old account that you paid

off it will actually hurt your credit

score

it's almost like the system was designed

to keep you in debt for as long as

possible

go figure factor number four is your

credit

mix this one is responsible for about

one-tenth of your credit score

lenders like it when they can see you've

got a variety of different active

accounts

so it's good mainly for your credit

score when you have at least a couple of

long-term loans like a mortgage and some

student loan debt

and a couple of credit cards it shows

you're responsible and can manage

different types of debt simultaneously

factor number five is

new credit this last one is also

responsible for about one

tenth of your credit score when you

apply for a new credit card or a new

loan

that lender pulls a copy of your credit

report

this is called an inquiry inquiries are

bad

for your credit score an inquiry every

year or two

is alright and won't have too much of an

impact but any more than that

and banks start to worry that you're

opening too many accounts

too quickly in general an inquiry will

disappear from your credit report after

two years

hey you made it to the end of this video

congrats here's a little secret to help

you bump up your credit score

ask one of your close friends or family

members to add you

as an authorized user on one of their

credit card accounts

you don't want a separate credit card or

anything you just want your name

listed on the account becoming an

authorized user

can be a triple play for your credit

score if you choose which account to be

added to wisely

it can increase your credit mix and your

length of credit history

and it can reduce your credit card

utilization percentage

that's a win-win win got any questions

about credit scores

anything i missed let me know in the

comments if you want to know more about

what it takes to achieve a credit score

of

800 or higher click right here

and if you're not already a ppf

subscriber then what are you waiting for

click right here to join the fun as

always

thanks for watching i'm andrew scheer

and i'll see you

next time