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Car Insurance

Does my credit score affect my insurance rates?

Car insurance companies claim that there is a correlation between your credit score and how likely you are to file a claim or be at fault in an accident. Do you know your credit score?

You have all the information you need to get car insurance--your driving record, your car’s make and model, your monthly average mileage--but what about your credit score? Some providers will use your credit history to determine your rates, but why? Let’s break it down.

What is a credit score?

A credit score is a three digit number between 500 and 850 that indicates your financial responsibility. The number is determined using a few factors, but most importantly your past credit history. Money lender companies use this score to determine how likely you are to pay back loans. If you have a higher score and therefore pay your bills, you’re considered a low risk borrower. However, if you have a lower credit score you’re marked as a high risk to lenders.

The Fair Isaac Corporation (FICO) produces the most commonly used credit score formula in the United States. While each money lender has a different idea of what is a “good” score, FICO generally uses the following numbers:

  • 300 - 629 Bad credit

  • 630 - 689 Fair credit

  • 690 - 719 Good credit

  • 720 or higher Excellent credit

Surprisingly, the average credit score in the U.S. is 695. If you find yourself below this average with a credit score of 500 or less, it may be more difficult for you to take out loans or you’ll be faced with higher interest rates once you do get a loan. However, your credit score affects a lot more than just borrowing loans. Having a poor credit score can impact your ability to start a business, finance a home, and afford car insurance.

What does my credit score have to do with my premiums?

Car insurance companies claim that there is a correlation between your credit score and how likely you are to file a claim or be at fault in an accident. This correlation has been proven in a study by Bureau of Business Research at UT’s McCombs School of Business and so, providers use this statistic as a reason to raise their rates for drivers with poor credit scores. The study concluded that drivers with a poor credit score had higher incurred losses and therefore costs the insurance provider more money to cover. Therefore, it’s estimated that drivers with poor credit scores pay an average of $214 more a year on their premium than drivers with good scores. But, if you think you have a good credit score, think again. Insurance providers often don’t use the FICO credit formula to determine their customers’ scores because they reserve the right to make their own models and algorithms that will provide them with an even stronger correlation between a person’s financial responsibility and how much they expect to pay to do business with this person.

If you think this is unfair, you’re not alone. Many believe that a driving record should be enough to indicate how much of a risk you are to a provider. A company’s ability to use a credit score to increase a person’s insurance rates, known as red-ling, is seen as discriminatory because it’s built upon the social, racial, and economical disadvantages deep-rooted in low income and minority groups. The Consumer Reports union advocates the banning of red-lining in all 50 states, however it’s only currently not being used in California, Hawaii, and Massachusetts.

How can I improve my credit score?

Even if you do live in a state that doesn’t use credit score to determine insurance rates, it’s always smart to maintain a good, clean credit score by:

  • Bills, bills, bills Pay your bills on time by setting up automatic payments or reminders on your phone or calendar.

  • Don’t get too close to your credit limit Financial experts advise keeping your use of credit at no more than 30% of your overall limit. This will keep you from maxing out.

  • Keep it balanced Closing out multiple credit cards and only using one may hurt your credit score if you get too close to or go over your limit.

  • Stick around The more experience you have with using and paying credit, the more information companies have to determine if you’re financially responsible. Maintaining a good credit score over a long period of time definitely has its benefits.

  • Only take what you need You should only apply for credit that you need. Money lenders are suspicious of those who apply for a lot of credit in a short period of time because it appears that your financial situation has changed negatively.

  • Keep track of your spending Keep track of written checks, credit card transactions, ATM withdrawals, and your monthly statements and report any discrepancies.

  • Check your report Check your credit score report regularly to ensure the information is correct. Reports are compiled by using your debts, payment history, and information such as your address or occupation. Websites like AnnualCreditReport will send you a free credit report every year.

  • Have an emergency fund In the unfortunate event that you lose your job or have an unexpected, large expense, it’s smart to have an emergency savings fund of three to six months’ living expenses in a liquid, interest earning account. Or you could keep a 15% cushion of credit available.

Even if you don’t have the best credit score, you’ll still be able to find discounts on car insurance. You’ll just have to shop smarter. Quote comparison sites like Insurify.com allow you to customize, build, unlock discounts, and purchase a policy online in minutes so you can get insured and out on the road.