Why Does Your Credit Score Affect Your Auto Insurance Rates?

Car insurance companies use your credit history to set your rates in most of the country. The only states that don't allow this are California, Hawaii, Massachusetts, and Michigan. It's a controversial practice, and it can have a huge impact on how much you pay for auto insurance.

The overall average for annual car insurance premiums is $3,017. It's just $1,947 for drivers with excellent credit, according to research on how credit scores affect auto insurance rates by The Motley Fool Ascent. Drivers with poor credit pay far more -- an average of $4,145.

If you're wondering why your credit score would have anything to do with your car insurance, here's the answer.

Drivers with poor credit are more likely to file insurance claims

When car insurance companies set your rates, they use an insurance score. Several factors go into this insurance score, including your credit history. Some of the other big ones are your age, driving record, location, and the type of car you drive.

All these factors are related to risk. Younger drivers are more likely to be in an accident than older drivers, so they pay more on average. A driver with a clean record is less likely to be in an accident than a driver with speeding tickets or DUIs.

The same is true with your credit score. Drivers with lower credit scores are more likely to file car insurance claims. There have been several studies that have reported this, including by the Federal Trade Commission (FTC) and the American Property Casualty Insurance Association.

Filing more claims costs insurance companies more money. That's why they set higher rates for drivers who are statistically more likely to file more claims, including those with bad credit. While this can be frustrating, it also means you could cut your insurance costs by raising your credit score.

How to improve your credit score

If you don't have a high credit score, it's good to make that a goal. After all, the difference between average annual premiums with excellent credit and poor credit is $2,198. In addition to saving on insurance, you'll also qualify for lower interest rates on loans and better credit cards, to name a few more perks of good credit.

Improving your credit score isn't complicated. It's sometimes even possible to make big changes in a matter of months. Here's how:

• Use a free credit score tool to see where you're at. There are lots of ways to get your credit score online. These tools also let you know what factors are negatively affecting your credit. With that information, you can come up with a plan to improve it.
• Pay down credit card debt as much as possible. A large part of your credit score is based on your credit utilization. This is how much of your credit you're using. If you have high credit card balances, and you pay them down, it can quickly boost your credit.
• Never miss a payment. Your payment history has the greatest impact on your credit. Late payments count against your credit once they're at least 30 days past due. They can do serious damage to your credit score -- as much as 110 points.
• Don't apply for new credit cards or loans too often. Each credit application will require a hard credit check, which has a small impact on your credit score. It's not a huge issue, as it usually only takes a few points off your score. But when you're working on your credit, it's better to avoid anything that can lower it.

Keep an eye on your credit using the free credit score tool you choose. When it has increased, go rate shopping to see what kind of deals you can get. It takes a little work to build your credit, but it's all worth it once you qualify for lower insurance rates.