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How and Why Does Your Credit Score Affect Your Auto Insurance Premiums?

Are you a first-time car buyer wondering how much you’ll pay for car insurance? Did you know insurers use your credit score to determine your annual premium? Yes! While banks use your credit rating when giving loans, auto insurance companies use the same to calculate premiums.

As a prospective car buyer, this may come as a surprise, especially if you currently have a poor credit score. Understanding how your score affects auto insurance helps you make suitable adjustments that will see you pay lower premiums.

With this in mind, keep reading to learn more about how and why your credit score affects your car insurance. The info will help you to analyze your standing before visiting a dealership to purchase your first car!

A Brief History of Credit Scores and Auto Insurance

Auto insurance companies didn’t always use credit rating as a determining factor in calculating premiums. Credit-based insurance scores were introduced in the early 1990s. They involved the use of some aspects of a person’s credit rating to underwrite their auto insurance policy.

Despite this, a credit-based insurance score varies significantly from your standard credit score. The latter looks at various factors that affect your ability to repay a loan. These factors include your loan repayment history, length of credit history, new credit, age, and many others. A credit-based insurance score looks at some but not all of these factors to determine your risk exposure and calculate premiums.

How Does Your Credit Rating Affect Your Car Insurance Premiums?

How does not paying your loans on time affect your ability to be a safe driver? Tough question! Ideally, there isn’t a direct connection between one’s credit score and their exposure to auto risks. However, insurers still use a poor credit rating to charge more for auto insurance.

Unfortunately, most states don’t prohibit insurance companies from using credit-based insurance scores. According to research, around 92% of insurance companies use credit scores in underwriting auto insurance policies. Only three states have banned the practice: California, Hawaii, and Massachusetts. Thus, if you don’t live in any of these states, your credit score will ultimately determine how much you pay in premiums.

So, how exactly does your credit score affect your auto insurance premiums? 

When you approach an insurance company to insure your vehicle, they will ask you to fill out some paperwork. Among the information you provide are personal details that will help the insurer access your credit score from companies that create the scores.

When analyzing your credit score, your insurer will look for the following information:

• Length and age of your credit history 
• Evidence of new credit acquisition 
• Types of credit you currently have 
• Bankruptcy information 
• How close you are to your credit limit 

The insurer uses the data to determine the total cost of auto insurance claims you’re likely to make in the future. They use an algorithm to calculate your premiums based on this information.

This fact may not make much sense to you, but according to studies, credit scoring is correlated to risk. Another research shows that drivers with a bad credit score make more claims than those with a good credit rating.

Average Cost of Auto Insurance Premiums

For example, in Texas, private drivers incur an average of $1,008 for car insurance premiums every year. For the average first-time driver, a poor credit score could increase these premiums by over $120 per year on average. On the other hand, a good credit rating would boost the rating by over $200 per year.

Insurance companies never reveal the algorithms they use to calculate premiums. However, an initial low credit rating will earn you a high premium quotation. Subsequent dips in your score will increase your premiums for the following years.

Why Does Your Credit Rating Affect the Price of Your Insurance Premiums?

Auto insurance is premised on the fact that an auto-related risk would cause losses that would jeopardize your financial state. Insurance companies require you to give them a certain amount of money every year in premiums. In return, they protect you from incurring financial losses after the occurrence of an insured risk.

However, insurance companies are in business and approach this issue from a business perspective. For example, let’s say you pay $600 in annual premiums. You make claims totaling to $1,000 in one year. Your insurer would suffer losses as a result. To avoid this, insurance companies pre-determine your level of risk exposure to determine how much you should pay for premiums. If they conclude that you’re likely to make claims worth $900, they will charge premiums totaling to $1,000 or more to cover the risk.

Credit Score as a Risk Assessment Factor

These companies use your credit score, not to determine behavior as is the case with financial institutions, but to assess risk. From the research associating poor credit with high risk, one could then conclude than an individual with a low credit rating would be more likely to make insurance claims than one with a good credit score.

Owing to this conclusion, the insurer will then assign you higher premiums to cover the risk of you making multiple claims in a year. Thus, during policy underwriting, drivers with similar properties such as age, gender, and type of car may pay different premiums merely based on their different credit scores.

Luckily, your auto insurance premiums are not set in stone. Positive changes in your credit score can significantly lower your next year’s premiums and save you money. Similarly, negative factors such as failure to pay loans on time affect your credit score and impact your credit-based insurance score.

Final Thoughts

Obtaining auto insurance is a must-have for every driver. However, before you purchase your first car, know that your current credit score will affect how much you pay for premiums. Auto insurance companies use information from your credit report to estimate the number of times you’re likely to file auto insurance claims.

The insurer feeds this information into an algorithm and uses it to generate your annual premiums. With this knowledge in mind, you can take measures to improve your current score before buying a car to make savings on auto insurance.