Speaker 1: This is just about everything you need to know about credit scores. 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, ten 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. 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 0. Having a credit score of 0 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 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 could 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 80% paid off, that's good. But if you just financed a brand new BMW 5 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 $1,000 limit. If the balance on your statement is $100, you're in good shape. But if the balance on your statement is $850, 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 one-sixth 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 PPS 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.