Credit scores play an increasingly important role in our financial lives. It affects whether you get approved for credit accounts, such as mortgages, car loans, and credit cards, and the interest rate you pay.
However, even if you don’t plan on financing a big purchase or using a credit card, you may be shocked to learn that your credit history affects you in many ways that have absolutely nothing to do with debt.
Credit also affects:
- how much you pay for insurance
- whether you can get approved to rent an apartment or home
- whether a potential employer will hire you
- whether you 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.
Why Insurance Companies Use Credit to Set Rates
On the surface, it may seem strange that an insurance company would evaluate your credit when insuring your vehicle or home. However, 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.
Insurers have been evaluating your credit for more than a decade--it's just one more tool to help them determine risk. They use credit to set rates for auto and home insurance in most states.
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 five 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 carriers 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.
What Are Credit-Based Insurance Scores?
When it comes to auto and home insurance, about 90% to 95% of insurers 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.
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.
It’s wise to shop your auto and home insurance policies every year to see if you qualify for a lower rate. There’s no downside to shopping because it doesn’t hurt your credit. And if you don’t find a lower rate, you can stay with your current company.
How Much Credit Affects What You Pay for Insurance
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 it:
- 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 2017 insuranceQuotes study found that across the nation, consumers with poor credit pay an average of 114% more for home insurance than those with excellent credit. Even having fair credit costs you 36% more on average than if you have excellent credit!
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 104% and fair credit was 28%, when compared to having auto insurance with excellent credit.
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.
Laura Adams is the Senior Insurance Analyst for insuranceQuotes.com. An author, spokesperson and national media source, she helps consumers improve their personal finances by making money easy to understand.
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