How Your Credit Affects Car Insurance Prices

You know your credit score is crucial when you apply for a credit card, a mortgage, or a car loan. But did you know it also plays a significant role in determining how much you pay for car insurance? It’s a factor that often surprises drivers, yet it can have a substantial impact on your annual premiums. Insurers have found a strong statistical correlation between a person’s credit history and their likelihood of filing a claim, making it a key element in their risk assessment.

What is a Credit-Based Insurance Score?

First, let’s clarify a common misconception: the score your auto insurer uses is not the same as your traditional FICO or VantageScore credit score that lenders use. Instead, insurers use what’s called a credit-based insurance score. While it’s derived from the information in your credit report, it’s calculated using a different proprietary algorithm.

This specialized score is designed to predict one thing: the likelihood that you will file an insurance claim. It doesn’t predict your driving skill, but rather your level of financial risk and responsibility. The insurance industry’s data, gathered over many years, indicates that individuals who manage their finances responsibly are also more likely to be responsible in other areas of their life, including driving and vehicle maintenance, leading to fewer claims.

The Key Difference from a Standard Credit Score

• Purpose: A lender’s credit score (like FICO) predicts the likelihood you’ll repay a debt on time. A credit-based insurance score predicts the likelihood you’ll file an insurance claim.
• Factors: While both scores use information from your credit report, the weighting of certain factors can differ. For instance, an insurance score might place more emphasis on a long history of consistent payments, while a lending score might be more sensitive to recent credit applications.
• Information Not Used: It’s important to note what insurers do not consider when calculating your score. By law, they cannot use personal information such as your race, color, religion, national origin, gender, marital status, or age. They also don’t look at your income or specific purchasing habits.

The use of these scores is a widespread practice. According to FICO, one of the leading creators of these scoring models, about 95% of auto insurers in the United States use credit-based insurance scores in states where it is legally permitted.

Why Do Insurers Use Credit History to Set Rates?

The fundamental business of an insurance company is to accurately price risk. To do this, they use a wide range of data points to create a detailed profile of each applicant. They need to predict how likely a driver is to cost them money in the form of a paid claim. While traditional factors like your driving record, the type of car you drive, and your location are paramount, credit-based insurance scores have emerged as a powerful predictive tool.

The Statistical Correlation Between Credit and Claims

Numerous studies conducted by independent organizations and regulatory bodies have confirmed the statistical link between credit history and insurance claims. The Federal Trade Commission (FTC) released a comprehensive report to Congress in 2007 that supported this correlation. The report found that, on average, consumers with lower credit-based insurance scores were more likely to file more claims, and those claims were often more expensive, than consumers with higher scores.

From an insurer’s perspective, this data suggests that individuals with a history of late payments, high debt levels, or collections accounts may exhibit behaviors that translate to higher risk on the road. This could be anything from neglecting vehicle maintenance that could prevent an accident to being more prone to financial stress, which can be a distraction while driving. By using this data, insurers believe they can price their policies more accurately, allowing them to offer lower rates to lower-risk individuals.

Which Credit Factors Influence Your Insurance Score the Most?

Since a credit-based insurance score is built from your credit report, the same habits that help you build a strong traditional credit score will also help you earn a favorable insurance score. Insurers are looking for a long-term pattern of financial stability and responsibility.

Here are the most influential factors, generally in order of importance:

• Payment History: This is the single most important factor. A long history of making payments on time for all your credit obligations (credit cards, loans, mortgage) is a strong positive signal. Conversely, late payments, collections accounts, and bankruptcies will significantly lower your score.
• Credit Utilization: This refers to the amount of revolving credit you’re using compared to your total available credit. Keeping your credit card balances low (ideally below 30% of your limit) demonstrates that you are not overextended financially.
• Length of Credit History: A longer credit history provides more data for the scoring model to analyze. Insurers view a long and positive credit history as a sign of stability.
• New Credit: Applying for multiple new lines of credit in a short period can be a red flag. It may suggest financial distress and is often viewed as a risk factor.
• Credit Mix: Having a healthy mix of different types of credit, such as an auto loan, a mortgage, and a few credit cards, can positively impact your score. It shows you can manage various types of financial obligations responsibly.

By focusing on these key areas, you can directly influence your credit-based insurance score and, consequently, your auto insurance premiums.

How to Improve Your Credit-Based Insurance Score

If you suspect a less-than-perfect credit history is inflating your car insurance rates, the good news is that you have the power to change it. Improving your credit-based insurance score is a marathon, not a sprint, but consistent, positive habits will lead to better scores and lower premiums over time.

Actionable Steps for a Better Score and Lower Premiums

1. Check Your Credit Reports for Errors: You are entitled to a free credit report from each of the three major credit bureaus (Equifax, Experian, and TransUnion) every year through AnnualCreditReport.com. Review them carefully for any errors, such as accounts that aren’t yours or incorrect late payment notations. Disputing and correcting inaccuracies is one of the fastest ways to improve your score.
2. Pay Every Bill on Time: Set up automatic payments or calendar reminders to ensure you never miss a due date. Your payment history is the most heavily weighted factor, so consistency is key.
3. Reduce Your Credit Card Balances: Actively work to pay down your credit card debt. Focus on keeping your balances well below 30% of your total credit limit. For example, if you have a card with a $10,000 limit, try to keep the balance under $3,000.
4. Avoid Opening Unnecessary Accounts: Only apply for new credit when you truly need it. Each application for new credit can result in a hard inquiry on your report, which can temporarily lower your score.
5. Keep Old Accounts Open: Don’t close old credit card accounts, even if you don’t use them often. Closing an old account can shorten the average age of your credit history and increase your overall credit utilization ratio, both of which can negatively impact your score.

By taking these steps, you are not only positioning yourself for cheaper car insurance but also improving your overall financial health, opening doors to better rates on all future loans and credit products.

Are There States Where Using Credit for Insurance Rates is Banned?

Yes. While the majority of states allow the use of credit-based insurance scores, a few have enacted laws that ban or significantly limit the practice. As of the latest regulations, the practice is banned for setting auto insurance rates in:

• California
• Hawaii
• Massachusetts

In these states, insurers must rely solely on other factors, such as your driving record, age, gender (in some cases), vehicle type, and location to determine your premiums.

Additionally, a few other states have placed certain restrictions on how credit information can be used. For example, some states may prohibit insurers from using credit as the sole reason to deny coverage or cancel a policy. Because regulations can change, it’s always a good idea to check with your state’s department of insurance for the most current rules.

What to Do If Poor Credit is Hurting Your Insurance Rates

If you’re currently struggling with a low credit score and are facing high insurance premiums, don’t despair. In addition to working on the credit-improvement steps outlined above, here are some strategies you can employ right now:

• Shop Around Aggressively: This is the most effective immediate strategy. Different insurance companies place different levels of emphasis on credit-based insurance scores. Some may be more forgiving of a poor credit history than others. Get quotes from at least three to five different insurers, including both large national carriers and smaller regional companies.
• Ask About Discounts: Make sure you are taking advantage of every possible discount. This can include discounts for safe driving, bundling your auto and home insurance, being a good student, taking a defensive driving course, or having certain safety features in your car.
• Increase Your Deductible: A higher deductible (the amount you pay out-of-pocket before your insurance kicks in) will result in a lower premium. Just be sure you choose a deductible that you can comfortably afford to pay on short notice.
• Re-evaluate Your Coverage: While you never want to be underinsured, you might be paying for coverage you don’t need. For example, if you have an older car with a low market value, it might not be cost-effective to carry collision and comprehensive coverage.

Take Control of Your Financial Profile

The link between your credit history and your car insurance rate is a clear example of how responsible financial management can pay dividends in all areas of your life. While it may seem unfair to some, insurers view it as a statistically valid way to price risk accurately. By understanding what a credit-based insurance score is, which factors influence it, and how to improve it, you can take proactive steps to lower your premiums.

Focus on building a strong credit history by paying bills on time, keeping debt low, and regularly monitoring your credit reports. And most importantly, remember to shop around for insurance regularly. The company that gave you the best rate three years ago may not be the most competitive option for you today, especially if your credit score has improved. By being a savvy and informed consumer, you can ensure you’re never paying more than you have to for the vital protection that car insurance provides.