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Can A Low Credit Score Lead To Higher Car Insurance Rates?

By Kade Phillips

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Published: 05Aug2010
Word count: 741
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Suppose your FICO score is 600. While this isn't subprime territory, it is low enough that your borrowing costs will rise through higher interest rates. The question is, can your score's influence on your life extend beyond mortgage loans, lines of credit, and other sources of consumer financing. The answer, at least in the context of your car insurance rates, is yes.

Auto insurers have used FICO scores for years to help them determine the risk posed by insuring any given individual. Just as a lender will use your score to decide whether to extend a loan, so, too, will your insurance company use it to calculate your premiums.

Below, we'll explore how your insurer uses your credit history to assign a risk score to your policy. We'll also explain how your FICO score is calculated, and describe some of the problems inherent with this type of risk modeling.

The Connection Between Your Credit Score And Car Insurance Premiums

If your FICO is a dismal 550, does this mean you're more likely to get into a car accident than someone whose score is 800? Not necessarily, but insurers have increasingly depended on these numbers to model the risk assigned to each policyholder. There are a number of correlations they have been able to draw between a tarnished credit history and a risk of future claims.

For example, insurance companies contend those who have bad credit are more likely to make poor decisions on the road. These decisions increase the likelihood of being involved in an accident, which in turn raises the odds of future claims. This increases the insurer's potential for loss.

A low FICO score also suggests a history of late payments. This issue is a serious one - more serious than many consumers realize. Car insurance companies avoid insuring people who are likely to pay their premiums late. In fact, they routinely cancel policies due to late or non-payment. By checking a consumer's credit history prior to extending coverage, the insurer can better assess the chances of late payments.

So, given the importance of your credit history and FICO score, how is the latter calculated? More importantly, what can you do to improve it, and thus lower your auto insurance rates?

How Your FICO Score Is Calculated

The Fair Isaac Corporation, which designed the credit scoring system used by the main credit agencies, keeps their formula hidden. However, they have publicly revealed some of the attributes that are taken into account.

The largest portion of your score is determined by your past payment history. The next largest is determined by the amount you owe creditors. At 35% and 30% of your score, respectively, these two categories are of particular interest to insurance companies who want to avoid late and non-payment issues.

The remaining portion of your FICO is split between three areas. The length of time your credit history has been established is weighted at 15%; new credit accounts, including inquiries, are weighted at 10%; and the types of accounts open in your name is weighted at 10%.

These latter three categories are important, but of lower priority for your auto insurer. The main goal for car insurance companies is to identify policyholders who show signs of stability, and to reward them with lower premiums.

Credit, Claims, And Risk Assessment

The use of credit histories in insurance risk scoring can lead to both positive and negative outcomes beyond the obvious. For example, suppose your driving history is littered with tickets and demerit points. In the past, most insurers would have balked at extending coverage without placing your policy into a high-risk class. Some might have refused to insure you at all. But suppose you have sterling credit (e.g. a score of 800), indicating stability. In this case, many insurers would be willing to extend coverage at more reasonable rates.

Consider a different scenario. Suppose you have a clean driving record, but due to a medical emergency, have gone deeply into debt. Struggling under a limited budget, some bills go unpaid. Your FICO score predictably declines. In this case, some insurance companies might raise your premiums due solely to your tarnished credit, regardless of your clean driving record.

The above scenarios present a compelling argument for shopping around. Each insurance company uses your FICO score differently to calculate their risk and your premiums. For this reason, invest the time to compare auto insurance quotes side by side to find the coverage you need at the best possible price.

Kade Phillips is a financial writer who writes for a Canadian car insurance comparison website - Kanetix, where you can compare the rates from the best insurance companies. At Kanetix you can also compare travel insurance, health insurance, life insurance, mortgage rates and more.

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