The Truth About Credit and Insurance Rates
Money Girl explains the relationship between your credit and what you pay for insurance. Find out which states allow credit to be used in setting rates, which types of policies are affected, and exactly how much having fair or poor credit can cost.
A member of the Dominate Your Debt Facebook group named Melanie asks:
“My husband and I are over 30 years old and have clean driving records. Even though we have every discount possible and high deductibles, I feel that we pay too much for car insurance. But our credit scores are fair—do car insurance companies use your credit score to determine your rates?”
In this episode, I’ll answer Melanie’s question and discuss the relationship between your credit and what you have to pay for different types of insurance.
You’ll learn why insurers care about credit in the first place, how the rules for using credit vary depending on where you live, and exactly how much poor credit can cost.
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The Truth About Credit and Insurance Rates
If you’re a regular Money Girl podcast listener or reader, you already know that credit plays a huge role in your financial life. It affects whether you can get approved for credit accounts—such as mortgages, car loans, and credit cards—and the interest rate you pay for them.
Whenever I write or talk about building and maintaining great credit, some people push back and tell me that having good credit doesn’t matter because you shouldn’t have debt or credit cards in the first place.
For the record, I don’t agree with that point of view. Using credit cards responsibly and taking on debt that you can afford can be extremely wise.
For instance, buying a home that appreciates in value, getting a car that allows you to go to work, or attending college so you learn valuable skills. These are examples of how leveraging someone else’s money can allow you to build wealth over time.
The important point that well-meaning, anti-credit advocates are missing is that credit affects you in many ways that have absolutely nothing to do with going into debt. Credit also affects:
- how much you have to pay for insurance
- whether you can get approved to rent an apartment or home
- whether a potential employer who checks credit history will hire you
- whether you can qualify for certain types of government benefits.
When you understand that credit affects much more than your ability to get a credit card, you realize that building and maintaining good credit should be one of your top financial priorities. Otherwise having poor or fair credit will cost you.
See also: 5 Ways to Get a Loan with Bad Credit
Why Insurance Companies Use Credit to Set Rates
Studies by insurance industry regulators, universities, insurance companies, and independent auditors have shown that consumers with good credit file fewer insurance claims, and therefore are less risky customers.
On the surface, it may seem strange that an insurance company would evaluate your credit when insuring something like your vehicle or home. Let me explain why they care and the types of polices that are affected.
In order for an insurance company to be profitable enough to pay out all the potential future claims it will receive, it has to take in more than enough money in premiums from customers. If they miss the mark and can’t afford to pay out your claims, they go out of business.
So insurers are interested in how often you’re likely to file claims and how expensive those claims could be. They use complicated predictive modeling based on claims they received in the past. Additionally, insurance is regulated at the state level, so companies have to set rates based on what’s legally allowed in each state where they want to do business.
Studies by insurance industry regulators, universities, insurance companies, and independent auditors have shown that consumers with good credit file fewer insurance claims, and therefore are less risky customers. That’s why insurers have been evaluating your credit for more than a decade—it’s just one more tool to help determine risk.
Insurance companies can use credit to set rates for auto and home insurance in most states. I’ll tell you which states prohibit the use of credit in just a moment. Some states also allow life insurers to evaluate your credit for policies that exceed a certain amount.
But credit is not a factor when it comes to your health insurance. According to the Affordable Care Act, known as Obamacare, insurers can only use 5 factors when setting health rates:
- where you live
- your age
- the size of your household
- whether you use tobacco (in most states)
- the type of plan you choose
The rating factors for health insurance are much more restrictive than other types of insurance. Health insurers can’t use your credit, gender, or even the state of your health when setting rates, no matter if you get coverage through an employer or on your own.
Free Resource: Credit Score Survival Kit—a free video tutorial to with smart strategies to build credit.
What Are Credit-Based Insurance Scores?
When it comes to auto and home insurance, about 90% to 95% of carriers use a credit-based insurance score to evaluate you. This is different than a regular credit score, such as FICO or Vantage Score, which mortgage lenders or credit card companies may use.
Both types of scores use information in your credit report; however, they’re trying to forecast different things. Insurance scores help predict how likely you’ll be to have a future insurance loss and file a claim. And a regular credit score helps predict how likely you are to repay a debt.
Unlike a regular credit score, you don’t have access to an insurance score because there’s no standard model used by all insurers or credit agencies. Insurance companies don’t let the public know precisely how they use your credit to set rates because underwriting methods are highly guarded in the industry.
See also: Best Tips to Improve Your Credit Score
How Often Do Insurers Check Your Credit-Based Insurance Score?
Different carriers check your credit-based insurance score at different times, but it’s typically used when you apply for a new policy—not every time your existing policy is up for renewal.
In other words, changes to your credit probably won’t affect your premiums once you’re already signed up for a policy. That can be helpful if your credit gets worse, but also means you could be overpaying if your credit has improved over time.
The best advice I can give is to shop your auto and home insurance policies every year so you can find out if you qualify for a lower rate. There’s no negative side effect for shopping. And if you don’t find a lower rate, you can stay with your current company.
See also: What You Should Know About Credit-Based Insurance Scores
How Much Credit Affects What You Pay for Insurance
As I previously mentioned, insurance is regulated by states, so the rating rules vary depending on where you live. While no state allows credit to be the only factor in setting rates, a few states have banned its use completely:
- Auto insurance policies for residents of California, Hawaii, and Massachusetts can’t be rated using credit history.
- Home insurance policies for residents of California, Maryland, and Massachusetts can’t be rated using credit history.
You might be surprised by how much your credit can affect what you have to pay for insurance.
A 2015 insuranceQuotes study found that across the nation, consumers with poor credit pay an average of 100% more for home insurance than those with excellent credit. Even having fair credit costs you 32% more on average than if you had excellent credit!
The study breaks down the data by state and shows that homeowners in Montana pay the most when they have fair credit, 66% more than residents with excellent credit. The next most expensive are Washington D.C. (61%), Texas (55%), Colorado (54%), and Arizona (54%).
Another insuranceQuotes study about the impact of credit on auto insurance also showed huge increases, but they’re not quite as high as the impact of credit on home insurance.
The average increase for having poor credit was 91% and fair credit was 24%, when compared to having auto insurance with excellent credit. The most expensive states for having auto insurance and fair credit are Missouri (28%), Mississippi (28%), Louisiana (28%), Alabama (27%), and Illinois (27%).
Let’s get back to Melanie’s question. The answer is yes, auto insurance companies use your credit when setting rates. But how much it affects your rate, or whether it can be considered at all, depends on the state where you live.
When you build and maintain a good credit history, you’ll see the benefits in many areas of your financial life, including paying less for auto and home insurance premiums.
If you’re ready for help managing debt, building credit, and reaching big financial goals, check out Laura’s private Facebook Group, Dominate Your Debt! Request an invitation to join this growing community of like-minded people who want to take their financial lives to the next level.
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About the Author
Laura Adams received an MBA from the University of Florida. She’s an award-winning personal finance author, speaker, and consumer advocate who is a frequent, trusted source for the national media. Money-Smart Solopreneur: A Personal Finance System for Freelancers, Entrepreneurs, and Side-Hustlers is her newest title. Laura’s previous book, Debt-Free Blueprint: How to Get Out of Debt and Build a Financial Life You Love, was an Amazon #1 New Release. Do you have a money question? Call the Money Girl listener line at 302-364-0308. Your question could be featured on the show.
