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SAL KHAN What, at a very high level, what defines credit?
FARNOOSH TORABI Really good question. So there’s probably
a lot of ways to define credit, but to keep it really, really simple, I think the best
way to explain it is that it’s a measure of how trustworthy of a borrower you are,
and, um, it’s, it’s from the eyes of people like, um, loan officers, banks, even as you
said earlier, um, potentially your landlord, uh, these are the people in this, in, uh,
in, in the industry who want to know if they’re going to need to give you a loan, or, um,
give you a lease, that you will be good for that money. And your credit, which comprises
of a score and your report, two separate things, reflect ultimately, um, you know, how again,
how trustworthy you are as a borrower to pay that money back.
SAL KHAN I see. It’s kind of like your financial
reputation?
FARNOOSH TORABI Exactly.
SAL KHAN I see. And, and just, and, and just following
up on this, this is from Carolina from Massachusetts, and Kevin from Arizona, and we’ll, we’ll
throw this question over to Ian, they ask, “What goes into a credit score? How is it
calculated?”
IAN COHEN Great. So, um, very common question. The credit
score is a measure, a numerical measure of a consumer’s ability and willingness to
pay their bills, and it’s measured according to five, um, areas that all make some, some
sense once you hear what they are. So 35 percent of your score is, um, uh, based on your payment
history. If you pay your bills on time, you’re going to get full credit for 35 percent of
your score. Uh, 30 percent of your score is based on how much debt you’re utilizing.
So if you have a credit card that has $1,000 of balance on it, or limit, rather, and you
run $100 of revolving balance every month, you have a 10 percent utilization, fantastic.
Um, from there, it’s the age of your credit, how long your credit has been active. Um,
next is mix of credit, and finally, it’s called “inquiries”, which measures how
often do you apply for credit. So, um, excuse me ... and so that’s, that’s, uh, uh,
a quick overview of your score. And in general, um, I, I think that to Farnoosh’s earlier
comment, it is a numerical resume for consumers, and it’s not the entire picture that lenders
SAL KHAN And, and just to dig one, one layer deeper
there, out of those metrics I’d assume for the, your payment history, the more you’ve
paid on time, the better, for, uh, things like, uh, for p-, for the length of credit,
uh, the longer that you’ve had credit, the better, but what about things like utilization?
What ... is, is there an optimal? Is it good to have zero utilization, is it good to have
full utilization, or is it something in between?
IAN COHEN So the people with the best credit scores,
or the average credit score in the country, uh, is 696, and the median credit score is
732. Most of those people, uh, are utilizing 10 percent or less of their total credit limits.
In general, that’s pretty ambitious, though. So what we recommend to consumers is that
try to stay below 25 percent. That’s a good, safe place to be.
SAL KHAN And so in general it is good to use your credit,
but stay maybe roughly below the 25 percent threshold?
IAN COHEN That’s correct. If you don’t use your
credit at all, um, you’re going to have no credit history, and if you don’t use
your credit cards at all, they’re going to likely get cancelled eventually. So even
if you don’t use your credit cards often, take them out for an occasional test drive,
uh, just don’t spend too much money on them.
SAL KHAN Right, right. And that, uh, and you already,
you addressed some of the questions ... this came from Candi(?) from Brunswick, Georgia,
uh, Beatrice (Inaudible) from North Carolina, “What is a good credit score?” You, you
already touched on that idea, is that you really want to get as close to the kind of
high 700s, low 800s as you can?
IAN COHEN Yeah, so to (Inaudible) what’s a good credit
score, so the very best rates you’re going to get on a loan or a credit card, um, generally
happened when you, when you reach a credit score of 750 or higher. And that’s the very
best rates. That said, 680 to 720 is absolutely a good score. Um, you know, the higher the
better, but, uh, you know, depending on where you’re at, uh, you, you can only do so much,
and 680 to 720 is a perfectly reasonable score, and puts you in the average for the United
States.
SAL KHAN I see. And just following up on that, I’ll,
I’ll hand this question over to Farnoosh. This is Jeannette(?) from Tampa, Florida,
and she’s asking, “Why, why, why having ... why is a good credit history a great,
a good credit score valuable? How, how does it actually impact us in the long-term?”
FARNOOSH TORABI Great question. So a good, a great credit
score equates to saving money. And here’s why. As Ian pointed out, when you have the
best score, and he said 750 or higher, now you’re in business to really negotiate the
best rates possible on, uh, products like students loans, private loans, um, car loans,
mortgages, et cetera. And so think about it, if you can have a great score that can earn
you a low interest rate at ... then every year you’re going to be saving money, compared
to somebody who has maybe a lower score, gets a higher interest rate, they’re going to
have to pay more interest over the life of that loan. So, uh, a great score, in short,
is money saved.
SAL KHAN And then not only ... and, and those, th-,
you know, few percentage points might not seem like a lot, but that could be a, a significant
amount in terms of ... dollar terms, especially on something like a mortgage.
FARNOOSH TORABI Exactly. Especially since a mortgage, as you
pointed out, is 30 years. So it does add up.
SAL KHAN Right. And it’s not always either a good
score versus a bad score, sometimes it’s whether you’re getting the loan at all.
FARNOOSH TORABI Exactly, yeah.
SAL KHAN (Laughs)
FARNOOSH TORABI I mean, some banks don’t want to be in business
with you, you know, if you don’t have at least a certain score.