How to Lower Your Car Insurance Premiums by Improving Your Credit Score
A Simple Guide to Understanding Your Credit-Based Insurance Score
It might seem strange that your credit score has anything to do with your car insurance rates. After all, you’re not taking out a loan to buy the policy. But for most drivers, in most states, your credit history is a major factor in determining what you'll pay for your car insurance.
The reason is simple: Data. Insurers have found a strong statistical link between a person’s credit history and their likelihood of filing an insurance claim.
A driver with poor credit is, on average, more likely to file a claim than a driver with excellent credit, even with a clean driving record. To a car insurance company, this means a higher risk, which translates to a higher premium.
Let's dive deeper into this relationship, and what it means for you.
Credit-Based Insurance Scores vs. Your FICO Score
First, it's important to clarify that car insurance companies don't use your standard credit score, like a FICO or VantageScore, to calculate your rates. Instead, they use a specialized "credit-based insurance score."
This is a proprietary formula that takes information from your credit report and uses it to predict your risk of filing a claim.
While the exact algorithms are a closely guarded secret, the factors that influence your regular credit score are the same ones that impact your insurance score. These include:
Payment History: Are your bills paid on time? This is the most critical factor.
Outstanding Debt: How much do you owe? High credit utilization (the amount of credit you're using compared to your limit) can negatively affect your score.
Length of Credit History: A longer history of responsible credit use is seen as a positive.
New Credit: Opening several new credit accounts in a short period can signal financial distress and may lower your score.
Credit Mix: Having a variety of credit types (e.g., credit cards, a car loan, a mortgage) can demonstrate responsible management of debt.
Why Do Insurance Companies Use Credit Scores?
The practice of using credit history for insurance underwriting has been around since the 1990s and is based on a fundamental principle of the insurance industry: risk assessment. Insurers are in the business of predicting risk.
They use a wide array of factors to determine how likely you are to cost them money. Your driving record, age, location, and the type of car you drive are all part of this equation.
Statistical analysis has consistently shown that a person's credit history is a powerful predictor of future claims. The Federal Trade Commission (FTC) conducted a study that confirmed this correlation, concluding that credit-based insurance scores are "effective predictors of risk." This doesn't mean that having a low credit score causes you to be a bad driver, but rather that financial stability and responsibility are linked to a lower likelihood of filing a claim.
For insurers, using credit-based scores allows them to more accurately price policies, ensuring that a driver's premium more closely aligns with their individual risk profile. This also, in theory, allows them to offer more competitive rates to low-risk customers.
The Impact on Your Premiums
The difference in premiums between a driver with excellent credit and one with poor credit can be staggering. In some cases, a driver with poor credit could pay more than double for the same coverage as a driver with a similar driving record and excellent credit. The exact impact varies by state, insurer, and your individual profile, but the effect is undeniable.
This practice is not without controversy. Critics argue that it unfairly penalizes low-income individuals and creates a cycle where those who can least afford higher premiums are forced to pay them. Because of these concerns, a handful of states have taken action to limit or ban the practice.
States Where Credit Scores Are Not a Factor
If you live in one of the following states, your car insurance rates should not be affected by your credit history:
California
Hawaii
Massachusetts
Michigan
Additionally, some other states have placed restrictions on how credit can be used. For example, in Maryland, insurers can use credit history to set initial rates, but they cannot use it to deny a new policy or refuse to renew a policy. In Utah, credit can be used to offer discounts but not to raise rates.
How to Take Control and Lower Your Rates
If you live in a state where credit is a factor, improving your credit-based insurance score is one of the most effective ways to lower your car insurance premiums over the long term. Since this score is based on the same information as your regular credit score, the steps you take to improve one will benefit the other.
Here’s an action plan:
Check Your Credit Report: You can get a free copy of your credit report from each of the three major credit bureaus (Equifax, Experian, and TransUnion) once every 12 months at
AnnualCreditReport.com Pay Your Bills on Time: This is the single most important factor. Set up automatic payments to ensure you never miss a due date on credit cards, loans, or other bills.
Reduce Your Credit Card Balances: Keep your credit utilization ratio as low as possible. Aim to use less than 30% of your available credit, and ideally even less. Paying down balances can give your score a quick boost.
Avoid Opening New Credit Accounts: Resist the urge to open multiple new credit cards or loans in a short period. Each "hard inquiry" can temporarily ding your score.
Shop Around: A better credit score can open up new opportunities for lower rates. When it's time to renew your policy, get quotes from several different insurers. They each have their own formula for calculating rates, and a good credit score may qualify you for significant discounts with certain providers.
By understanding the relationship between your credit score and your car insurance rates, you can take proactive steps to improve your financial health and save a substantial amount of money on your premiums.
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