How Credit Can Impact Your Insurance Rates
Having good or bad credit can impact many aspects of your life.
Your ability to secure a car loan or a home mortgage hinges on your credit score. Some recruiters even look at one's credit score when interviewing job applicants.
However, many people might not realize that their credit scores also can impact what they end up paying for insurance.
The Fair Credit Reporting Act, passed in 1970, made it legal for insurance companies to check into the credit history of an applicant to determine whether or not to issue a new policy or renew an ongoing policy. Insurance companies also can base an applicant's insurance premium on his or her credit score. This practice is commonly seen for all types of insurance, including auto insurance and homeowners insurance.
How Your Credit Score is Determined
Sometimes referred to as a "FICO score," your credit score is a three-digit number that demonstrates your credit history and theoretically predicts your future behavior. For example, if your credit score is low because you defaulted on a loan, a creditor might interpret that mark on your credit as an indication that you could default on a loan again and as a result deny you credit or charge you higher-than-normal interest rates.
When it comes to credit scores, the higher the number is, the better your credit score is.
To determine your credit score, the three credit bureaus weigh various aspects of your credit history - certain aspects of your credit history carry more weight than other aspects.
In general, your credit score is based on the following breakdown:
- Payment History - 35 percent
- Amount of Total Debt Owed - 30 percent
- Length of Credit History - 15 percent
- Amount of Newly Acquired Credit - 10 percent
- Types of Credit Used - 10 percent
As noted, a consumer's payment history will have the greatest impact on his or her credit score, which is why it is so important to pay all your bills on time and to do whatever you can to avoid defaulting on any loans.
Some consumer might not realize that they actually have three credit scores - one for each of the three credit bureaus: Experian, TransUnion and Equifax. While these three scores can vary, they generally will be similar in rating.
How a Bad Credit Score Can Raise Your Insurance Rates
Insurance companies that use applicants' credit scores when approving policies argue that there is a direct link between an applicant's financial stability and his or her insurance-related losses. They contend that financially responsible consumers are likely to have fewer and less costly losses than consumers who have shown less financial responsibility.
There are two primary ways in which insurance companies use an applicant's credit score:
Underwriting
During the underwriting process, an insurance company is determining whether or not to issue a new policy. Many factors are considered when making this determination, such as an applicant's driving history when applying for auto insurance.
Often, an applicant's credit score is included among these factors. It is important to note, however, that some states do prohibit the use of one's credit score alone to determine whether or not to approve a new insurance policy.
Rating
In order to determine a policyholder's insurance premium, insurance companies rate that policyholder or assign them to a "tier" - the better your assigned "tier" is, the lower your insurance premiums will be. Often, one's credit score is among the many factors considered when rating a policyholder.
Many insurance companies do consider several factors when assigning policyholders to a "tier," but some states do allow insurance companies to determine this placement based on credit score alone.
