When calculating car insurance premiums, many insurance companies use a variety of factors to assess the level of risk posed by a policyholder. One of these factors, which might come as a surprise to some drivers, is their credit score. Insurers often use credit-based insurance scores to determine how likely you are to file a claim, which in turn influences the premium you pay. This practice has raised debates, but for many drivers, understanding how credit scores impact insurance premiums is essential.
This article will explore the relationship between your credit score and car insurance premiums, how insurers use credit information, and what you can do to improve your rates.
What Is a Credit-Based Insurance Score?
A credit-based insurance score is a type of credit score used specifically by insurance companies to predict the likelihood of a policyholder filing a claim. This score differs slightly from a standard credit score, which is used by lenders to assess your ability to repay loans. Both scores, however, are derived from your financial history and credit behavior, including factors like your payment history, outstanding debt, and length of credit history.
Factors That Affect Your Credit-Based Insurance Score:
- Payment History: Whether you consistently pay your bills on time.
- Outstanding Debt: The total amount of debt you have across loans and credit accounts.
- Credit History Length: How long you’ve been using credit.
- Types of Credit: The variety of credit accounts you maintain (e.g., credit cards, loans).
- New Credit Inquiries: The number of times you’ve recently applied for new credit.
Why Do Insurers Use Credit Scores?
Insurance companies use credit scores because studies have shown that there is a correlation between a person’s financial responsibility and their likelihood of filing a claim. Drivers with lower credit scores may be seen as higher-risk clients because statistics suggest they’re more likely to file claims, leading to higher payouts for the insurer.
By including credit scores in the assessment, insurers can better predict which customers are likely to cost them more money over time. As a result, drivers with higher credit scores tend to pay lower premiums, while those with poor credit might see an increase in their rates.
How Credit Scores Affect Car Insurance Premiums
The exact impact of a credit score on car insurance premiums can vary by state and by insurer. Some states, such as California, Massachusetts, and Hawaii, prohibit the use of credit scores when determining auto insurance premiums. However, in states where this practice is allowed, the effect can be significant.
Key Impacts:
- Higher Credit Scores = Lower Premiums: Drivers with excellent credit scores can expect to pay lower premiums since they are considered low-risk.
- Lower Credit Scores = Higher Premiums: If you have a low credit score, insurers may view you as more likely to file claims, which could result in higher premiums.
- Tiered Pricing: Insurers often place customers in tiers or brackets based on their credit scores, with each tier having a different premium range. Those in the top tiers enjoy the lowest rates, while those in the lower tiers face higher costs.
Example:
If a driver with a high credit score (750 or above) pays around $1,200 annually for car insurance, a driver with a poor credit score (under 600) might pay $1,800 or more for the same coverage.
States That Limit or Ban the Use of Credit Scores
As mentioned earlier, some states have banned or restricted the use of credit scores in determining auto insurance rates. These states argue that credit scores are not a reliable indicator of driving behavior and that using them can disproportionately affect certain demographics.
States with Restrictions:
- California
- Hawaii
- Massachusetts
- Michigan (restrictions apply in certain contexts)
In these states, insurers rely more heavily on other risk factors like driving history, age, and location when calculating premiums.
How to Improve Your Credit Score for Better Insurance Rates
If you live in a state where credit scores affect insurance premiums, improving your credit score can directly lead to savings on your car insurance. Here are some steps to help raise your credit score:
1. Pay Bills on Time
Consistently paying your bills on time is one of the most effective ways to boost your credit score. Late payments can negatively impact your score, so set up reminders or automatic payments to avoid missing deadlines.
2. Reduce Credit Card Balances
High credit card balances relative to your credit limit can lower your credit score. Aim to keep your credit utilization rate below 30% of your available credit to positively impact your score.
3. Avoid Opening Too Many New Accounts
Each time you apply for new credit, a hard inquiry is added to your credit report, which can temporarily lower your score. Avoid opening multiple credit accounts within a short period unless absolutely necessary.
4. Monitor Your Credit Report
Regularly check your credit report for any errors or discrepancies that could be hurting your score. You’re entitled to a free credit report from each of the three major credit bureaus—Equifax, Experian, and TransUnion—once per year. Dispute any inaccuracies to have them removed.
5. Diversify Your Credit Mix
Lenders and insurers like to see a mix of credit types, such as installment loans (like car loans or mortgages) and revolving credit (like credit cards). A diversified credit profile can help improve your score over time.
Alternatives to Credit-Based Premiums
If you have a poor credit score and are looking to reduce your insurance premiums, there are alternative factors that insurers take into account. Consider asking your insurer how these may impact your rates:
1. Telematics or Usage-Based Insurance
Some insurers offer usage-based insurance programs, where your premium is determined by your driving behavior rather than your credit score. These programs use telematics devices or mobile apps to track driving habits, including speed, braking, and mileage. Safe drivers can receive discounts based on their actual performance on the road.
2. Accident-Free Discounts
Maintaining a clean driving record with no accidents or claims can qualify you for lower premiums. Many insurers offer good driver discounts that reward policyholders who have been accident-free for a certain number of years.
3. Low-Mileage Discounts
If you don’t drive often, you may qualify for low-mileage discounts, as drivers who log fewer miles are less likely to be involved in accidents.
Conclusion
Your credit score plays a significant role in determining your car insurance premiums in many states. Insurers use credit-based insurance scores as a measure of risk, with drivers who have high credit scores typically paying lower premiums. However, if your credit score isn’t as strong as you’d like it to be, there are steps you can take to improve it, potentially leading to reduced premiums over time.
Understanding how your credit score affects your car insurance rates can help you take control of both your financial health and your insurance costs. By improving your credit score, exploring alternative insurance options, and taking advantage of available discounts, you can work toward securing a more affordable car insurance policy.