With a solid credit score, you are able to borrow money at the most competitive interest rates. But that’s not all—creditworthy behavior could also help you save hundreds of dollars on your insurance policies annually.
Most auto and homeowners insurance companies use a type of credit score—known as an insurance score or a credit-based insurance score—to decide whether to issue a policy and at what terms.
Insurance companies use information in your credit report to help them predict how likely you are to file an insurance claim and how much that claim could cost. In general, auto and homeowners insurance companies find that consumers with higher credit scores are less of a risk, which means these consumers are more likely to be offered insurance—and lower rates. While consumers with lower insurance-based credit scores are more likely to file claims, those with solid credit generally drive responsibly and take good care of their homes.
For example, according to a new report from InsuranceQuotes.com, drivers with poor credit-based insurance scores dish out almost twice as much for car insurance (91 percent more, to be exact) than drivers with excellent credit scores. Drivers with median credit-based insurance scores pay 24 percent more than drivers with excellent credit.
By using credit-based insurance scores, insurers are able to distinguish between lower and higher insurance risks and then charge consumers a premium equal to the risk the insurance company is accepting.
How is a credit-based insurance score calculated?
Similar to your credit score, your credit-based insurance score is derived from information in your credit report. The two scores, however, are different.
Many insurance companies have their own proprietary methods for evaluating credit information. However, your credit-based insurance score is typically created using about 20 to 30 pieces of financial data, including outstanding debt, length of credit history, late payments, collections, bankruptcies, and new applications for credit.
Most of your credit-based insurance score—about 40 percent—is determined by payment history, while outstanding debt accounts for about 30 percent of your score.
Remember that credit is just one factor used to determine your insurance premium. When applying for auto insurance, for example, factors such as your driving record, age, gender, and where you live also affect your rate. For homeowners insurance, your home’s construction and location will also come into play.
What if I am denied insurance because of my credit?
Not all states allow insurance companies to use credit-based scores to set premiums. In California, Hawaii, and Massachusetts, for example, credit can’t be used to determine auto insurance rates. By checking with your state insurance department, you can learn how insurers in your state use credit information.
According to the Fair Credit Reporting Act (FCRA), if you are denied insurance or given less favorable terms because of the information in your credit report, the insurance company must give you a notice with the name, address, and phone number of the credit reporting agency that furnished the information. In addition, you will be able to obtain a free copy of your credit report.
In order to help improve your credit score, regularly monitor your credit report so you know where you stand. If you spot any inaccuracies, file a dispute with the credit reporting agency so the information can be corrected. Paying your bills on time, keeping your debt-to-credit ratio low, and opening new credit only when necessary can all also help you boost your credit score over time.
Ilyce Glink is the author of ten books, including the bestselling 100 Questions Every First-Time Home Buyer Should Ask. Her nationally syndicated column, “Real Estate Matters,” appears in more than 125 newspapers and Websites, and her online “Ask Ilyce” columns are read by hundreds of thousands of people every month. She is a top-rated radio host on WSB Radio in Atlanta, the Home Equity blogger at CBS MoneyWatch.com, host of the Internet program “Expert Real Estate Tips,” managing editor of the Equifax Personal Finance Blog, and publisher of ThinkGlink.com.