Why does your credit impact your insurance rates?

You may not realize just how important your credit is to your financial wellbeing. Many people know how good credit can make it easier to get a loan or credit card with low rates. You may have also experienced a landlord checking your credit as part of the rental application process.

But did you know your credit can also impact how much you pay for insurance?

Many insurers use credit-based insurance scores

In most states, insurance companies can create or buy credit-based insurance scores to help determine your monthly premium.

These credit-based insurance scores aren’t the same as the credit scores that banks and credit card issuers use when you apply for a loan or credit card. However, they’re based on the same underlying information – your credit reports.

A history of paying bills on time might help your insurance score, while late payments, defaults, accounts in collections or other negative marks might hurt your insurance score.

Unlike consumer credit scores, some insurance scores might consider information that isn’t on your credit reports, such as how close you live to a fire station (for a home insurance score).

Insurance companies generally can’t solely rely on a credit-based score to deny, cancel or refuse to renew your insurance policy. However, your insurance score could play an important role in determining your insurance rates.

Poor credit could cost you big money

Insurance companies often use credit-based scores for auto and homeowners insurance policies.

A score’s impact on your premium can depend on your insurance score, the insurance company and a variety of other factors, such as whether you recently filed a claim. That’s one of the reasons shopping around for insurance can help you save money.

In some cases, a low score could be quite costly. A Consumer Reports study from 2015 found that poor credit cost drivers an average of $1,301 a year in auto insurance premiums. In some states, auto insurance was more expensive for someone with poor credit than someone with excellent credit and a driving while intoxicated (DWI) conviction.

Why can your credit impact your insurance?

By this point, you may be wondering why insurance companies are allowed to consider your credit history. After all, having poor credit doesn’t necessarily mean you’re a bad driver. Similarly, you could have excellent credit and be terrible behind the wheel.

Some states may agree, which is why insurance companies can’t use credit-based scoring everywhere.

In Georgia, Maryland, Oregon, and Utah there are limitations on when and how insurers can use credit-based scores. California, Hawaii, and Massachusetts outlaw the practice altogether.

Where it is allowed, insurance companies might cite a 2003 University of Texas study or a separate Federal Trade Commission study from 2007 that found a correlation between a person’s credit and the likelihood that the person will file an insurance claim.

In short, people with poor credit tend to file more insurance claims and cost insurance companies more money. As a result, insurance companies might charge them higher premiums.

Checking credit-based insurance scores

While there are many ways to check consumer credit scores for free, figuring out your insurance scores isn’t as easy. Insurance companies often build custom scoring models, and they’re not required to share their trade secrets.

There are a few sources for more information, though.

LexisNexis is one of the companies that creates third-party insurance scores, and some insurers (such as Esurance) may purchase a LexisNexis score instead of creating their own score. You can get a copy of your LexisNexis credit reports and can purchase your LexisNexis Attract insurance score.  Your score should come with up to four reason codes, the four most important factors in determining the score, and LexisNexis maintains a list of the codes and explanations for each one.

You can also check a TransUnion insurance score for free on Credit Karma.

Knowing your score only offers limited value, particularly when you don’t know which companies are using custom scores and which use a third-party score.

A better method may be to focus on what you can do to improve your credit, as your credit reports have the underlying information that impacts all your insurance scores.

What now? Build your credit

Like it or not, most people’s credit reports can impact their insurance rates. Even if you can’t figure out your insurance score, you can take steps to improve your credit.  Here are a few ways to get started:

  • Review copies of your credit reports and dispute any errors you find.
  • Pay your bills on time.
  • Try to pay down revolving debt, such as credit cards or lines of credit.
  • Sparingly apply for new credit

These steps can also improve your consumer credit scores, so taking action could be a win-win for your finances.

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