Your credit score is incredibly important because of how many parts of your life it affects. While it may not be outwardly apparent, your credit score has a large impact on your insurance rates, particularly car insurance. Some people think this is a myth, and while some companies choose to disregard credit score, the majority considers it to some degree.
Determining Insurance Costs
Insurance companies consider many different factors when they determine your insurance rates. These include factors such as age, gender, vehicle make, model and age, your address and your driving record. As many as 92 percent of insurance companies also take credit score into account. Because of the large number of factors, no one factor is going to skew your insurance rates completely. However, a credit score will have a sizable impact.
The idea behind taking a credit score into account when determining insurance rates is simple. If you're responsible with your money, you're probably going to be responsible in other aspects of your life. Conversely, if you have a record of not paying your bills on time, a company that relies on you paying your bills is going to want more assurance that they'll get their money.
The other side of the coin is those people who simply hit a rough patch in their lives. A person who has decades of good driving and good credit, but who loses their job and falls late on their bills, might find their insurance rates rising. This adds more stress to their lives and compounds the negative effect on their credit. This is a valid criticism of using credit score to determine rates, but it applies to a comparatively low number of people.
The Issue of Discrimination
By law, insurance companies are not allowed to discriminate according to gender, race or other personal classifications. The use of credit score is not discrimination, however, due to the lack of classifying information. A person's credit score is not tied to their race, age or gender, and so using the credit score in rate calculation is not itself discrimination.
Insurance rate calculation is a tricky use of statistics. In some cases, it may be true that people of a certain race or gender are more dangerous drivers than others in the same area. Insurance companies have to carefully draw a line between taking valid statistics into account and straying into discrimination. To satisfy this, they do not take factors such as race, occupation and employment history into account.
Details Regarding Credit Reports
What, specifically, is contained in your credit report? What makes up your credit score? These are complicated questions, but here is a general idea.
Your credit report contains a degree of personal information. This includes name, social security number, address, birth date, phone number and past addresses. Your credit score will contain much of this information as well -- it's not simply a number when insurance companies are concerned.
The report and score both include your financial history when it comes to satisfying your obligations to various financial institutions and stores. It will also include any public financial judgments, such as bankruptcies and wage garnishments.
Your report will also contain a list of the institutions who have requested your report in the last couple of years.
Errors in Credit Reporting
No method of financial reporting is completely without error. In some cases, errors will crop up in your credit report that will affect your insurance rates. It is possible for you to contact the agency responsible for the report to cancel the report and have the error fixed.
In the case of debts being sent to collections, it is possible to have this black mark removed from your report as well. While you cannot simply tell the agency not to report it, you can negotiate for what is called a Pay for Delete with the collections agency. In these negotiations, you essentially agree to pay a certain amount of your debt in exchange for the agency removing their report about the collections. This results in your score returning to the previous number, which is often an improvement. For minor debts or accidental non-payments, this can be of significant help.
Some people may be worried that the simply act of pulling your credit score will affect that score. This is because your credit report contains a list of the institutions that have pulled the report. However, this is not strictly true.
Your credit report contains two types of records regarding those who have pulled the report. These are called hard and soft inquiries. Hard inquiries are those made by financial institutions regarding loans and lines of credit. Soft inquiries are every other sort of inquiry.
When you pull your credit report, you are able to see both hard and soft inquiries. Any other institution pulling your report will only see hard inquiries. Because your insurance company pulling the report is a soft inquiry, it will have no effect on your score.
You are able to pull your own report free once a year from each of the three major reporting agencies. These agencies are Experian, Equifax and TransUnion. Other agencies pulling your report will not affect your ability to pull your report.
Using Credit in Insurance Calculation
While most insurance companies pull your credit report in order to determine your insurance rates, they do not use the whole report, nor do they use your credit score itself. Most insurance companies have a program that pulls your credit report and analyzes it. It takes certain factors into account and disregards others. This program then generates a new score, called your insurance score. This score is what is used in calculating your insurance rates.
The benefits of this are many. First, it means that some aspects of your credit report are not taken into account. This helps prevent discrimination, among other things. Second, it means that no employee of the insurance company sees your credit report directly. Only the relevant information is pulled and used in the insurance score, so your credit score is safe with you and the reporting agencies.
The Benefits of Using Credit Reports
The use of credit scores in insurance rate calculation is not simply a negative. While some drivers with bad credit scores will find their insurance rates climbing higher than they otherwise would, safe drivers with good credit will see the opposite effect. A good credit score informs the insurance company of your history of responsibility, and allows them to give you a lower rate in good faith because of your good history. This means that safer drivers will benefit more from a good credit score than they would with no credit reporting.
What Affects your Score?
Your credit score is affected in a positive way by the existence of open accounts in good standing, as well as a long credit history with no late or missed payments and no collections. In short, financial responsibility means a higher credit score.
On the other hand, your credit score can be affected negatively by late or missed payments, debts in collections, large amounts of outstanding debt, a short credit history or a high number of report requests in a short amount of time. This last is an indicator of rejection by financial institutions, though this is not always the case and no rejection is actually listed.
Studies done by the University of Texas, as well as by the Federal Trade Commission, indicate that credit score is an accurate predictor of risk. This means that insurance companies can accurately determine effective insurance rates by taking credit score into account. Because the practice allows insurance companies a higher degree of accuracy, it is unlikely to go away any time soon. The best course of action is to improve your credit score in any way you can.