It’s True: Bad Credit Can Mean Paying More for Car Insurance

Turns out your credit history is a pretty good indicator of how many claims you’ll file.

When you borrow money, a bad credit score means higher rates. Sometimes, it might even mean that you can’t borrow from a traditional lender at all. Instead, you’ll be stuck with dangerous no credit check loans like payday loans, cash advances, and title loans. Not great!

But there are many other ways that bad credit increases your cost of living. As it turns out, having poor credit is expensive! It can mean larger deposits to secure an apartment or to sign up for utilities—it can even mean trouble getting hired for certain kinds of jobs!

One of the myriad ways that having poor credit adds to your cost of living is through your car insurance. As it turns out, the higher your credit score, the lower your insurance rates! Unfortunately, that means that the opposite is also true: bad credit means paying more for car insurance.

How does your credit score work?

Your credit score is a three-digit number that expresses your creditworthiness as a borrower. It’s a number that traditional lenders like banks, auto dealerships, and mortgage companies use to help determine whether to lend you money and what kind of rates you’ll have to pay. The better your score, the more loans you’ll able to qualify for and the lower your interest rates will be.

Credit scores are based on the information in your credit reports, which contain records of how you’ve handled credit over the past seven years. (Some information, like bankruptcies, stays on your report for longer.) Credit reports are created and maintained by the three major credit bureaus: Experian, TransUnion, and Equifax.

The most common type of credit score is the FICO score. It’s based on a scale of 300 to 850, with 300 being the worst and 850 being the best. While definitions of “good,” fair,” and “bad” credit vary, generally any FICO score above 720 is great, any score between 719 and 630 is fair, and any score under 630 is bad.

There are five categories of information used to create your credit score: payment history, amounts owed, length of credit history, credit mix, and recent credit history. Your payment history and your amounts owed together make up 65 percent of your total score. For more on how each category works, check out our Know Your Credit Score blog series.

Why do insurers factor in your credit history?

Simply put, auto insurers look at your credit history when determining your insurance rates because …. that history is actually a pretty good indicator of how good a driver you are! We know, we were surprised too.

However, insurance companies don’t simply pluck out your regular credit score and use it determine your insurance rates. Instead, they take the same information that FICO takes from your credit reports and they use it to create a “credit-based insurance score.”

These credit-based insurance scores differ slightly from regular credit scores in that they aren’t designed to predict whether or not you’ll pay your bills. Instead, they are designed to predict how many claims you’ll file, as that’s the thing that insurers care most about when setting your rates. The more claims they think you’ll file, the higher your premiums will be.

In 2007, the Federal Trade Commission (FTC) released a report titled Credit-Based Insurance Scores: Impacts on Consumers of Automobile Insurance. According to that report:

“Credit-based insurance scores are effective predictors of risk under automobile policies. They are predictive of the number of claims consumers file and the total cost of those claims. The use of scores is therefore likely to make the price of insurance better match the risk of loss posed by the consumer. Thus, on average, higher-risk consumers will pay higher premiums and lower-risk consumers will pay lower premiums.”

Now, even though your credit-based insurance score is different from your regular FICO score, it’s safe to say that the two are also very similar. If you have a bad credit score, the odds are very good that you will also have a poor credit-based insurance score.

How can you improve your credit score?

Earlier in this post, we mentioned that your payment history and your amount owed are the two biggest factors in creating your credit score. Your payment history is the number one factor, making up 35 percent, with your amounts owed coming in a close second at 30 percent. Together, they make up 65 percent of your score, almost two-thirds of the total!

So, if you’re going to fix your score, you should focus on these two areas. The two most important things you can do to improve your credit score are paying all your bills on time and paying down your open balances. Furthermore, any open credit card balances you keep should stay under 30 percent of your total limit. This will help maintain a good credit utilization ratio.

If you don’t have your bills set up on autopay, you should go ahead and do that. Just make sure you’ve also budgeted properly so that your bill payments don’t result in bank overdrafts. And when it comes to paying down all that outstanding debt, we suggest either the debt snowball or the debt avalanche methods of debt repayment.

Fixing your credit score is hard. We know. But the benefits of having great credit will be felt all throughout your financial life. Lowering your insurance premiums could save hundreds or even thousands of dollars per year! What are you waiting for?!

To learn more about credit scores, check out these related posts and articles from OppLoans:

Did you see better insurance rates when you fixed your credit? Let us know! You can find us on Facebook and Twitter.

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The information contained herein is provided for free and is to be used for educational and informational purposes only. We are not a credit repair organization as defined under federal or state law and we do not provide "credit repair" services or advice or assistance regarding "rebuilding" or "improving" your credit. Articles provided in connection with this blog are general in nature, provided for informational purposes only and are not a substitute for individualized professional advice. We make no representation that we will improve or attempt to improve your credit record, history, or rating through the use of the resources provided through the OppLoans blog.