Jeffrey Wade
Credit scores are a significant factor in determining insurance rates. While it may seem odd that credit history influences insurance premiums, insurance companies argue that credit-based insurance scores allow them to quote the fairest rates for their customers. In most states, insurance companies use credit-based insurance scores to set rates for auto, renters, and homeowners insurance. Notably, a good driver with poor credit will pay significantly more for car insurance than a driver with good credit. Credit-based insurance scores are calculated using factors such as payment history, outstanding debt, credit history length, pursuit of new credit, and credit mix. It is important to regularly check one's credit report for any errors, as these could impact insurance premiums.
| Characteristics | Values |
|---|---|
| How insurance companies use credit history | To decide whether to sell insurance and how much it will cost |
| What insurance companies look at in a credit history | Number of open accounts, debt-to-credit ratio, past due payments, frequency of credit applications, medical debts, credit checks |
| Consumer rights | Companies must inform customers within 30 days if they are denying coverage or charging more due to credit reports |
| Consumer rights | Customers can ask for exceptions if their credit was affected by protected events |
| Consumer rights | Consumers can obtain a free credit report annually from Equifax, Experian, and TransUnion |
| Consumer rights | Consumers can ask for reconsideration in case of extraordinary life circumstances |
| Consumer rights | Consumers can ask if a credit-based insurance score was used to underwrite and rate their policy |
| Consumer rights | Consumers can shop around for insurance quotes to find more affordable options |
| Consumer rights | Consumers can improve their credit to save on insurance in the long term |
| Credit-based insurance scores | Are not the same as credit scores |
| Credit-based insurance scores | Are used in most states to determine insurance premiums |
| Credit-based insurance scores | Are calculated based on payment history, outstanding debt, credit history length, pursuit of new credit, and credit mix |
| Credit inquiries | Soft inquiries do not affect credit scores, hard inquiries can reduce scores by a few points |
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What You'll Learn
Credit scores impact car insurance premiums
In some states, such as California, Hawaii, and Massachusetts, insurers are prohibited from using credit scores to set prices. In these states, insurance premiums are primarily based on a consumer's driving record, the number of miles driven per year, and other factors. This approach ensures that insurance rates are calculated based on actual driving behaviour rather than predicted future risk.
It is important to note that credit scores can be influenced by various life events, such as catastrophic events, temporary loss of employment, or medical emergencies. If an individual's credit score is affected by such events, they may request reconsideration of their insurance premium. Additionally, regularly monitoring credit reports for changes or errors is essential, as it can impact insurance credit scores.
While credit scores play a significant role in determining car insurance premiums, it is not the sole factor. Other considerations, such as driving history, the type of vehicle, and the number of miles driven, also influence insurance rates. It is recommended to shop around and compare rates from different insurance companies, as well as to maintain a good credit score, to obtain the most favourable premiums.
Understanding how credit scores impact car insurance premiums is crucial for consumers. By being aware of the factors that influence their credit score and its potential impact on insurance rates, individuals can take steps to improve their creditworthiness and, consequently, obtain more favourable insurance terms.
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Credit-based insurance scores
FICO looks at five general areas that it believes will best determine how well an individual manages risk. These are:
- Payment history (40%): How well an individual has made payments on their outstanding debt in the past.
- Outstanding debt (30%): How much debt an individual currently has.
- Credit history length (15%): How long an individual has had a line of credit.
- Pursuit of new credit (10%): Whether an individual has applied for new lines of credit recently.
- Credit mix (5%): The types of credit an individual has (e.g. credit card, mortgage, auto loans).
It is important to note that credit-based insurance scores are not the same as regular credit scores. While most states allow insurers to use credit-based insurance scores to determine premiums, some states only permit it as one factor for property insurance, such as auto and homeowners insurance. Other states do not allow credit-based insurance scores to be used at all in determining rates or denying, cancelling, or not renewing policies.
Consumer groups have raised concerns about the use of credit-based insurance scores, arguing that it disproportionately affects certain minority and low-income groups. Additionally, these scores may not appropriately take into account unforeseen life events, such as the Covid-19 pandemic.
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How credit history affects insurance rates
Credit scores are based on an individual's credit history and reflect their financial standing or how likely they are to repay a loan or line of credit. Insurance scores, on the other hand, are insurer-generated numerical rankings based on a person's credit history and are used to set insurance rates.
Most insurance companies use credit history to help them decide whether to sell someone insurance and how much it will cost. When reviewing someone's credit, insurance companies typically consider the following factors:
- Number of open accounts
- Amount owed compared to available credit
- History of late or past-due payments
- Frequency of applying for new lines of credit
- Outstanding debt
- Length of credit history
- Pursuit of new credit and credit mix (types of credit)
Credit-based insurance scores allow insurers to quote what they consider to be the fairest, most appropriate rate for each customer. Statistics show that people with poor insurance scores are more likely to file a claim. Therefore, insurers charge a premium based on the risk they are assuming.
It is important to note that insurance companies cannot charge higher rates or deny coverage if someone's credit score was negatively impacted by certain protected events, such as a major illness, injury, or the death of a loved one. Individuals can also request that the insurance company make an exception if their credit was affected by any of these events.
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Credit checks and insurance coverage
Credit checks are a common part of the insurance application process and can impact the cost of your coverage. Insurers use credit-based insurance scores to determine insurance premiums, and these scores are calculated differently from regular credit scores. While a credit score is calculated based on factors such as payment history, outstanding debt, credit history length, pursuit of new credit, and credit mix, credit-based insurance scores only consider information pertaining to potential losses. This means that insurers are looking at factors such as how many open accounts you have, how much you owe compared to your available credit, any past due payments, and how often you apply for new lines of credit.
Credit-based insurance scores are used as a factor in determining premiums for homeowners, auto, and renters insurance. In most states, insurance companies are allowed to use these scores to set rates, and they are one of several factors considered in the underwriting process. For example, with auto insurance, other factors considered include the age of the operators, the make and model of the car, and the miles driven annually. Similarly, with homeowners insurance, factors such as the location and age of the home, as well as the insured's claims history, are also considered.
The impact of credit checks on insurance coverage can vary depending on the insurance company and the state in which you live. In some states, such as California, Oregon, Massachusetts, and Virginia, the use of credit-based insurance scores is banned. In other states, insurance companies are allowed to use these scores, but they must follow certain regulations. For example, under the Fair and Accurate Credit Transactions Act of 2003 (FACT Act), consumers are entitled to a free credit report annually, and insurance companies must notify the customer within 30 days if their credit report has led to a denial of coverage or an increase in rates.
It is important to note that credit checks related to insurance coverage can impact your credit score. When shopping for insurance, insurance companies typically perform a "soft" inquiry, which does not affect your credit score. However, a "hard" inquiry, which is a more thorough review of your credit, can lower your score by a few points. Therefore, it is recommended to check your credit report regularly and dispute any errors, as these can also impact your insurance premiums. Additionally, improving your credit score can help lower your insurance costs in the long run.
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Improving credit to save on insurance
Improving your credit score can help you save money on insurance. A good credit score can be a significant factor in getting a better insurance deal. While insurance companies use credit scores to assess the risk of potential losses, they also use them to determine how much it will cost you.
Insurance companies consider several factors when reviewing your credit history. These include how many open accounts you have, how much credit you are using, any past due payments, and how often you apply for new lines of credit. They may also consider medical debts that went to collection and credit checks from businesses that you didn't request.
If you have a poor credit score, you may be paying a lot more for your insurance. According to a study by Bankrate, drivers with a credit score below 580 pay, on average, 97% more for their car insurance than those with a score above 800. That's a difference of over $1,700 per year. However, improving your score, even by a small amount, can lead to significant savings. For example, increasing your score from poor to average could save you around $600 per year.
There are several ways to improve your credit score and save on insurance:
- Shop around for insurance deals: Getting quotes from multiple companies will not hurt your credit score, and you may find a better deal.
- Review your insurance regularly: At least once a year, review your existing insurance and compare it with other companies' offers.
- Bundle your insurance: You may get a discount by purchasing multiple types of insurance, such as homeowners, renters, or life insurance, along with your auto insurance.
- Choose a different type of car: Some insurance carriers offer lower premiums for alternative-fuel vehicles or cars with factory-installed safety features.
- Increase your deductible: This will lower your insurance rate but will cost you more if you need to make a claim.
- Look for discounts: Insurance companies offer various discounts, such as good student discounts, senior discounts, and safe driving discounts.
- Drop unnecessary extras: Review your policy for any extras you don't need, such as roadside assistance, and consider dropping them to save money.
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Frequently asked questions
No. When insurance companies request your credit-based insurance score, this does not change or "ding" your credit score. This is called a "soft pull" and will not affect your credit score.
Insurance companies use a credit-based insurance score to determine premium rates. This number is calculated using information from your credit report but is different from your credit score. A higher credit score correlates with a lower risk of claims, which results in lower premiums.
Paying down debt and paying bills on time can help improve your credit score. You can also review your credit report for any errors and report them to the relevant company.
Yes, insurance companies have to inform you within 30 days if they are denying you coverage or charging you more because of your credit report. You can ask the company to make an exception if your credit was affected by specific protected events.
You can request a free credit report from the three major consumer reporting companies: Equifax, Experian, and Transunion.
