How Your Credit Score is Calculated

One of the most important numbers associated with your life is your credit score. This three-digit number ranging from 300 to 850 will follow you through every major purchase, loan application and credit card application you process in your adult life. In fact, your credit score can affect seemingly unrelated things such as your insurance premiums. As a result, it's no surprise that consumers work diligently to improve and maintain their credit.

Consumers who have high credit scores - over 700 - find that they tend to receive preferable loan programs, pay less in interest and have a much easier time receiving approval for credit. If you're currently in the process of debt reduction and analyzing the debt you currently have, it's important to also review your credit score and take an honest assessment of your current credit health.

Every consumer's credit score is calculated differently. There is no set formula, which is why every individual must practice smart spending and payment habits to keep their score as high as possible. As a rule of thumb, you should think of your credit score as a seven-year window: The most recent activity on your credit report will have a greater impact than something from 10 years ago. However, consumers who have decades of excellent credit will receive preferential scores. This means that you should demonstrate good credit worthiness in both long-term loans (mortgages) and short-term borrowing (credit cards or auto loans). You can view your score online for a small fee by visiting any of the three major credit bureaus, Equifax, Experian and TransUnion.

Factors that go into determining a credit report

While every credit score is different and is determined through the analysis of a variety of factors, we do know some basic rules of thumb. Here are the main elements of your credit score:

• 35 Percent: Your Payment History. The biggest impact on your credit score is your daily and monthly payment habits. If you always pay your bills on time, you will find that you'll have a much higher score than your neighbor who tends to miss payments. Your creditors report your payment habits every month, so if you miss a payment it could have an immediate negative effect on your credit score. If you run into a problem and cannot make a payment, call your creditor immediately. You may be able to make arrangements - particularly if you're a consumer who has an excellent payment history.
• 30 Percent: Amounts Owed. Your credit score is an assessment of your overall credit worthiness, in other words your ability to take out debt and repay it. As a result, the credit bureaus give preferential scores to those consumers who carry a manageable amount of debt on their credit cards. As a rule of thumb, you should carry no more than 30 percent of the available credit on a card at any time. Meaning, if you have a card with $10,000 in available credit, you should never carry an ongoing balance of more than $3,000.
• 15 Percent: Credit History. Those consumers who have long-established credit - and good credit at that - receive a bonus in their credit scores. This is why it can be hard for young consumers to get a good credit score quickly. You can consider this a reward for smart spending and borrowing over a period of years and even decades.
• 10 Percent: New Credit. Consumers can think of this factor in two ways: Your new accounts, such as a car loan or a student loan, are analyzed more carefully because they're fresh on your account. But the ratio of new debt to old debt is also calculated, and this is where consumers should be careful. If you open a credit card, plan on keeping it for several years. The credit bureaus could penalize you if you open and close accounts quickly, and thus end up with only "new" accounts. You should strive for a good balance of older and newer accounts.
• 10 Percent: Types of Credit. Believe it or not, there is good debt as far as credit bureaus are concerned. If you demonstrate an ability to borrow and repay money, your credit score will rise. This is particularly true if you have a mortgage, auto loan, student loan and credit card debt all at once. This means that you're borrowing money not just for spending, but also for purchases that demonstrate credit worthiness such as a home.