How credit affects insurance premiums

Credit can influence some of life's big moments, like buying your first home or getting a new car.

That's because many of these large purchases require financing a mortgage or auto loan that gets paid off over time, rather than all at once. Your credit score helps lenders predict the financial risk of letting you borrow money when you apply for a loan. The better your credit score, the less you'll typically pay for a loan.

But what about insurance rates? Since premiums can vary like mortgage and auto loan rates, you might ask if your credit score will impact the amount you'll pay.

The short answer? No.

But that's not the whole story.

While your credit score may not factor into your insurance rate, your credit history will — in a credit-based insurance score. We'll walk you through the key details of this lesser-known score to help you understand why and how credit affects insurance premiums.

How credit scores work

Before we dive into how insurance is linked to credit scores, it may help to define the differences between three terms:

• Credit is a financial arrangement that allows you to borrow money and pay it back later. It can be tied to a specific purpose, such as your home, car or student expenses. Or it can be a line of credit that you use and pay off repeatedly, as with a credit card.
• Your credit history is just what it sounds like — your track record of borrowing money and paying it back on time – or not. An official document that showcases your credit history is called a credit report. Credit reports may include information about:
  • How much outstanding debt you have.
  • The type of debt you have, like credit cards or loans.
  • How long your credit accounts have been open.
  • Whether you've filed for bankruptcy.
  • Whether you've had an account sent to collections.
  • Whether you've recently applied for credit.
  • How well you keep up with payments.
• A credit score, also known as a FICO® score, is a calculation based on the information in your credit report. The better your credit activity, the better your score.

The three major credit bureaus — Experian™, TransUnion® and Equifax® — use information from your credit report to calculate credit scores. Each bureau calculates their score differently and may weigh certain pieces of information more heavily than others. Therefore, you'll have three different credit scores.

When you need a loan, your bank or financial institution will use your credit score to determine your creditworthiness. Different banks use different credit bureaus. A higher credit score, also known as "good credit," shows lenders you can be trusted to borrow money and pay it back on time.

It's riskier to lend you money with poor credit. As a result, having poor credit often means you'll likely pay higher rates on auto and home loans.

So where does that leave us with insurance?

Credit-based insurance score

As previously stated, insurance companies won't check your credit score so the actual number won't affect insurance rates. But they do look at your credit history on your credit report. And like credit bureaus, insurers use that same credit information to calculate an insurance score.^{See note1}

Although they're similar, insurance scores and credit scores serve different purposes. And they carry different weight when it comes to your interest or insurance rates.

Credit scores are designed to predict delinquency, meaning payments that are late or below the required amount. Lenders care a lot about credit scores because loan payments can be significant.

A mortgage payment can easily be $2,000 per month. It's not uncommon to see a car payment cost $500 to $700 a month. So late payments are a big deal.

With insurance scores, it's a different story. Compared with loan payments, insurance premiums are low. According to the most recent data from the Insurance Information Institute (III), the average annual homeowners insurance premium is $1,311 a year or about $109 per month. AAA research shows that the average “full-coverage” auto policy costs approximately $1,588 per year, or about $132 per month.

That's not to say that your insurance company doesn't care whether you pay your premium on time. However, late payments aren't the biggest risk that insurers face. They're much more concerned with predicting insurance claims and major losses.

At this point, you may be thinking, "So what does my credit history have to do with insurance claims?"

Well, according to the III, studies show that the better someone manages money, the less likely they are to file a claim.^{See note1} That means they're less of a risk for the insurance company, which typically results in lower rates.

Limits on insurance scores

Insurance scores can be helpful as companies decide what to offer and how much to charge for insurance. But many states restrict how insurance scores can be used. For instance, many states don't allow insurers to use an insurance score as the sole reason for a decision.

Other states, including California, Hawaii, Maryland, Massachusetts, Michigan, Oregon and Utah have even stricter guidelines about using credit information when underwriting or determining rates on a policy. Exact rules vary, so if you have questions, it's best to check the specific guidelines for your state.

Credit isn't the only factor impacting insurance rates.

An insurance score is just one of many factors that play into your home and auto insurance premiums. In fact, compared to other things like your claims history and the value of your home or car, your insurance score may have a small impact on your premium.

Ultimately, it's up to your insurer to decide how much your insurance score matters when they set rates. But you shouldn't be too worried. According to III, most people pay less for insurance because of insurance scores, not the other way around.