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Real world: A Tale of Two Credit Scores

Janae and Bob each want to buy the same model of car. But Bob's is more expensive than Janae's. A LOT more. Why is that? Is that even legal? Created by David Rheinstrom and Elvira Valdez.

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Video transcript

(jaunty music) - [Narrator] Khan Academy proudly presents "A Tale of Two Credit Scores." This is Janae. - [Janae] Hi. - [Narrator] And this is Bob. - [Bob] Good morning, narrator. - [Narrator] Hi, Bob. These two charming characters are coworkers, each with the same job and salary. They both need a vehicle, so they've traveled to this used car dealership together so they can each buy a new ride. - [Janae] I'm all about this model. It's got everything I need. It's got the all-wheel drive, it's got the adaptive braking, - [Bob] It's got the backup camera. - [Janae] And... - [Janae And Bob] It's a hatchback! - [Bob] Gonna carry so much furniture in this thing. - [Narrator] They are greeted by Susanna, an employee at the dealership. - [Susanna] Janae, Bob, I got your message. - [Janae] Oh, good. - [Susanna] These hatchbacks have been flying off the lot, but I've reserved one for each of you. You're both sure this is what you want? - [Bob] Definitely. We both did a lot of research. - [Janae] Yeah, we're both sure. But I've got a question. - [Susanna] Understandably. - [Janae] What's the damage? How much is this car going to cost? - [Susanna] We have this car listed at $13,750. After taxes and fees, we're looking at $15,500 out the door. Are you paying cash, or you both thinking about financing? - [Janae And Bob] Financing. - [Susanna] Okay, follow me inside. We've got some applications to fill out. - [Bob] Will there be oversized novelty pens? - [Susanna] Oh, yeah. - [Narrator] And so Janae and Bob got out their writing implements and entered the enchanting world of paperwork. They gave permission to the dealership to run credit reports on each of them. They answered a barrage of questions about their finances. Finally, Janae and Bob got their applications back from the dealership. - [Susanna] Okay, so I've got some good news and I've got great news. - [Bob] Great news first. - [Janae] Yeah. - [Susanna] Great news, Janae. We got you approved for a 36-month term with a monthly payment of $453. - [Janae] All right, I can afford that for sure. - [Susanna] Good news, Bob. You are also approved for the exact same 36-month term and a monthly payment of $584. - [Bob] Wait, let me do some math before I agree with you about it being good news. - [Susanna] It's good news. You are approved. - [Bob] No, help me out, Janae. Your loan comes to a total of... - [Janae] $16,308. And yours... - [Bob] $584 times 36. Let's see. That's $21,024. How am I paying almost $5,000 more than you? It's the same car. Is that legal? - [Narrator] Great question. Pause. What do you think is happening here? - [Bob] Is this even a question? Of course it's not legal. - [Narrator] Bob, I'm talking to the learners. We'll get back to you in a minute. - [Bob] So it is legal? - [Narrator] I said pause. - [Janae] Bob, he said pause. Come on. - [Bob] Sorry. - [Narrator] Where was I? What do you think is happening? Share your perspective with your classmates or write them down. Pause the video here and then enjoy five seconds of peaceful jazz music. (mostly peaceful jazz music) So what accounts for the vast difference between Bob's loan offer and Janae's loan offer? It all comes down to the credit score. Let's dig into that. The dealership asked a credit bureau to evaluate how risky it would be to loan money to Janae or Bob. Their credit scores are an illustration of that risk. Janae's credit score is 800, which is excellent. Great job, Janae. - [Janae] Thank you. - [Narrator] That score means that Janae is a low-risk borrower. Low-risk borrowers get low interest rates. She pays her bills on time, she uses her credit responsibly. Bob, on the other hand- - [Bob] Uh-oh. - [Narrator] Bob has a credit score of 500. To be blunt, this is a pretty bad credit score. Bob's credit report shows that he's consistently late paying his bills, he's outright missed a bunch of payments, and here it says he defaulted on a loan in the past. That's a huge red flag for a lender. - [Bob] But why is it more expensive for me than it is for Janae? - [Narrator] So given your credit history, they think it's likelier that you won't pay them for the full amount of the car. To make up for that risk, your loan carries a 21% interest rate, which means you are paying thousands of dollars more in interest over the life of the loan, 5,000 to be exact. - [Bob] And again, that's legal? - [Narrator] Afraid so. - [Bob] This sucks. Did you know credit scores were such a big deal? - [Janae] I knew a little, yeah. - [Narrator] I knew too. - [Bob] Of course you did. - [Narrator] After signing their contracts, Bob and Janae regroup at a coffee shop; Janae to celebrate, Bob to drown his sorrows in coffee. - [Bob] Another. - [Janae] I think you've had enough, pal. - [Bob] I'll stop when I'm good and ready. Ugh, how did everything get so expensive? - [Narrator] That's part of the problem, Robert, you didn't know when to stop. You maxed out your credit cards. - [Bob] I'm a free spirit. - [Narrator] You defaulted on that business loan five years ago. - [Bob] The market was not ready for chocolate-covered beef jerky. - [Janae] And it still isn't, Bobby. - [Narrator] And you ignored your credit report. Whereas Janae paid her bills on time. - [Janae] Thank you. - [Narrator] She kept her credit card balances low. - [Janae] Mm-hmm. - [Narrator] And she kept an eye on her credit score. - [Janae] They ran a credit check on me before I moved and my credit score helped me to rent my new place. The score is a reflection of the choices I've made. - [Bob] So Janae, how can I be more like you? Can credit scores change? - [Janae] They absolutely can. - [Bob] Okay. How? I assume there's not some magic wand. - [Janae] There isn't, but there are a lot of steps you can take. You can enroll in a financial literacy course. - [Narrator] Like this one! - [Janae] Exactly. You can monitor your credit with websites and apps like Credit Karma. And if you see something weird, you can dispute errors. Like one time, my credit report showed a boat loan. - [Bob] You don't have a boat. - [Janae] I never had a boat, but it dinged my credit and I successfully disputed that. I said, "That's not me," and they verified it. So there's that. But you'll also need to work on your debt. I can get you the name of a credit counselor if you want. - [Bob] I'd appreciate that very much, Janae. - [Janae] Yeah. On second thought, I might want another coffee. Can I get you anything? - [Bob] That's very kind, Janae, but I can't be opening up a new line of credit right now. - [Janae] You goober. It's on me, come on. - [Narrator] And so we leave our two friends to untangle the twisted bonds of credit to demystify the conundrum of risk to master their money and improve their lives. Remember that your credit score is one of the keys to your financial happiness. But a bad score is not destiny. You have the power to change it. Use credit responsibly, pay off your bills, and if needed, seek credit counseling. This has been "A Tale of Two Credit Scores." Thank you, and goodnight.