If you have bad credit, you might be wondering what options you have for car insurance. So how does bad credit affect car insurance rates? Find out here.

You may have read that bad credit can cause your insurance premiums to increase. But maybe you’ve ignored this advice. After all, it’s not intuitive. Plus, you might think, the difference can’t be that bad.

But a recent study from InsuranceQuotes actually shows just how important your credit score is when it comes to insurance premiums.

According to the study, someone with a middle-of-the-road credit score could expect to pay up to 36 percent more for home insurance than someone with excellent credit. And the gap between consumers with poor credit and those with excellent credit is even wider. In fact, in many states, consumers with poor credit could pay more than double what excellent-credit consumers pay for their home insurance!

The graphic below highlights the poor-vs-excellent credit score gaps for the top ten worst states:

A similar report by Consumer Reports shows that credit differences similarly affect auto insurance, though the effects are often less pronounced. This report breaks down some of the “dark side” of this practice. It notes the fact that car insurance companies basically cherry pick information from your credit report and feed it into their own algorithms. So consumers don’t have a clear picture of which credit scoring factors most affect their car insurance rates.

Why Does Bad Credit Affect Car Insurance Rates?

So it’s clear that your credit score does affect your insurance rates. But now the question is: why?

Credit scores are meant to predict consumer behavior. Your standard FICO credit score is set up to show how likely you are to default on debts. As such, it tells potential lenders how risky you would be to take on as a customer.

According to the National Association of Insurance Commissioners, the scoring process your insurance company uses is different. It’s called a credit-based insurance score, and it uses only certain elements of your credit report. The goal of the score is to show how likely you are to have an insurance loss. In other words, this form of your score shows how risky you are to insurers, rather than lenders.

Insurers are only allowed to use this type of scoring in some states, though most do allow it on some level. Like your credit score, your credit-based insurance score can’t take into account certain personal information like race, color, national origin, religion, gender, marital status, age, and location of residence. Though some of those factors do count towards your insurance premium calculation in other ways.

Is It a Good Indicator?

For a long time, credit information has been used to gauge whether or not you’re a generally responsible person. This is why even potential employers might pull a copy of your credit report. But does being irresponsible with your finances actually correlate with being responsible as a homeowner or driver?

Maybe, but maybe not.

One report by the Federal Trade Commission concludes that people with a lot of missed payments, debts, and recent credit inquiries are more likely to make a car insurance claim. This is one reason insurers are allowed to use this information in their pricing decisions.

With that said, some consumers and consumer advocates aren’t happy about the relationship between credit scores and insurance premiums. The InsuranceQuotes report points out that part of the problem is just how dramatic the relationship is between premiums and credit scores. This may unfairly disadvantage lower-income consumers. Sticking them with higher insurance premiums that, in turn, make it more difficult for them to improve their credit scores.

Plus, insurance companies don’t really know why credit scoring factors seem to correlate to insurance-related behavior. And consumers can’t see the credit-based insurance score that insurers use to make these decisions. This can make it hard for consumers to know how to put themselves in a better credit position for insurance purposes.

So What Should You Do?

The bottom line here is that improving your overall credit score will improve your credit-based insurance score, although the correlation isn’t necessarily one to one. So things like making payments on time, keeping your debt-to-credit ratio low, and leaving old accounts open so you have a longer credit history are all important.

Taking these steps shows you’re managing your finances well, which leads to a better credit score. This leads to a better credit-based insurance score. So you can save on both financial products and insurance.

• Get your free credit score from Credit Sesame
• Get your free credit score from Credit Karma

Topics: Insurance

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via Finance Xpress