No doubt, you're aware that your credit score can determine whether you get approved for a credit card or an auto loan. But did you know that your credit score can affect how much you pay for car insurance premiums? You may not have known because insurance companies are not obligated to tell you, but your credit score can have a significant effect on your insurance rates.
Let's take a look at how insurance companies rate their customers and find out what your credit score has to do with it.
How Do Auto Insurance Companies Set Rates?
Each insurance company has its own model to set its rates. These are the most common factors used to determine insurance premiums:
- Your driving history
- Accident and claims record
- Where you live
- Demographics including your age, gender and marital status
- Age, make and model of vehicle
- How the vehicle is used and miles driven per year
- Your credit score
While most of these factors make sense, you have to wonder what your credit score has to do with your driving skills.
How Does Your Credit Score Affect Your Car Insurance?
Auto insurance companies use your FICO credit score to create their own version of a credit-based insurance score. Your FICO score and a credit-based insurance score are not the same thing. Both scores consider the same factors, but they weigh them differently.
Lenders use your credit score to project the likelihood that you’ll default on your loan payments in the next 24 months. Insurance companies use their version of a credit score to determine the probability of you filing a claim that will cost them more than the premiums you pay. Studies have shown that people with low credit scores are more likely to file an insurance claim.
Although the connection is hard to explain, insurance companies believe that people with low credit scores will be poorer drivers and are more likely to be involved in at-fault accidents. Apparently, people who pay attention to their credit scores are also more careful drivers and take better care of their cars, like keeping up with the maintenance and parking it in a locked garage.
Fortunately, not all states allow auto insurance companies to use credit scores when setting rates. Currently, California, Hawaii and Massachusetts prohibit this practice.
If there’s any good news from this, inquiries from insurance companies on your credit score are not considered hard inquiries and should not affect your score.
What Effect Do Credit Scores Have On Rates?
WalletHub conducted an extensive survey of the five major auto insurance companies to find out how much a person's credit score would affect their car insurance rates.
According to this survey, drivers with no credit pay 67 percent more, on average, in car insurance premiums compared to those with excellent credit. The effect of poor credit compared to excellent credit varies by state.
Drivers with poor credit scores fare the worst in New Jersey, where rates are over double those with excellent credit. Here at the top five states where poor credit scores hurt the most:
- New Jersey - 102 percent
- Virginia - 97 percent
- Michigan - 92 percent
- Arizona - 91 percent
- Wisconsin - 91 percent
However, in some states, the cost of a low credit score is not as bad. These are the five states where low credit scores have the least impact on car insurance premiums:
- Montana - 27 percent
- Arkansas - 28 percent
- New Mexico - 37 percent
- Rhode Island - 41 percent
- Iowa - 42 percent
Coverage.com found similar differences in premium rates for those with poor credit compared to good credit scores. According to their survey, the national average insurance premiums for drivers with good credit was $1,555. On the other hand, drivers with poor credit paid an average of $2,424. That’s a difference of $869 per year or an increase of 56 percent over the premium for good credit scores.
These rates are continuously changing, so a good approach is to get new quotes every year or two.
Shop Around With Other Insurers
Shop around with different insurers because some weigh your credit score more heavily than others, especially if your credit score has improved.
For example, the WalletHub survey found that the difference in premiums between good credit and poor credit scores was the greatest with Farmers Insurance at 117 percent. Here's how the premium difference looked at the other major insurance companies in the survey:
- GEICO - 24 percent
- Progressive - 74 percent
- State Farm - 79 percent
- Allstate - 80 percent
- Farmers Insurance - 117 percent
Auto insurance carriers are constantly re-evaluating their algorithms and adjusting their rates to changing conditions. A rate that you received in a quote from one company a year or two ago might be different if you ask for new insurance quotes today. COVID-19 has changed a lot of the pricing models for many companies.
Follow These Steps To Improve Your Credit Score
Improving your credit score takes time. It's not going to happen over just a few weeks or even a few months. But if you have clearly defined objectives and know what you need to be doing, it’s worth the effort to bring your credit score up and save yourself a substantial amount of money with your car insurance premiums. Here are the steps to follow to improve your credit score:
- Review your credit reports from the three agencies and correct any mistakes.
- Pay all of your debts on time.
- Bring any past-due accounts current.
- Keep the utilization of credit cards to 30 percent or less.
- Don't close any credit cards with zero balances.
- Don't open any new credit card accounts.
Ways To Lower Your Auto Insurance Premiums
While you're working on improving your credit score, here are several discounts to reduce your insurance premiums in the meantime.
Safe driver discount: Drive carefully to avoid traffic tickets and getting involved in an accident. Take a defensive driving course and let your insurance company know.
Military discount: Some auto insurance companies offer discounts for military personnel. Find out if yours is one of them.
Low-mileage discount: If you don't drive many miles because you’re working from home, look for an insurance company that has a pay-per-mile program based on actual mileage driven. These premiums could be substantially lower than programs with estimated mileages.
Unless you live in California, Hawaii or Massachusetts, your credit score is going to have a significant effect on your auto insurance premiums. It’s unavoidable, and the effect can be a big difference in cost between poor credit and excellent credit.
- Experian: How Much Does Credit Score Affect Auto Insurance Rates?
- Insurance Information Institute: What Determines the Price of an Auto Insurance Policy?
- CreditKarma: How Do My Insurance Scores Affect My Car Insurance Rates?
- Coverage: Does Your Credit Score Affect Car Insurance?
- Progressive Insurance: Insurance Scores: What You Should Know
- WalletHub: Credit Score & Car Insurance Report
- Insurance Information Institute. "Background on: Credit scoring." Accessed Feb. 4, 2020.
- Sprint. "Cell Phones: Financing for Bad Credit, Good Credit, and More." Accessed Feb. 4, 2020.
- Federal Trade Commission. "Utility Services." Accessed Feb. 4, 2020.
James Woodruff has been a management consultant to more than 1,000 small businesses. As a senior management consultant and owner, he used his technical expertise to conduct an analysis of a company's operational, financial and business management issues. James has been writing business and finance related topics for work.chron, bizfluent.com, smallbusiness.chron.com and e-commerce websites since 2007. He graduated from Georgia Tech with a Bachelor of Mechanical Engineering and received an MBA from Columbia University.