Why are car insurance rates higher for drivers with bad credit?
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UPDATED: Mar 13, 2020
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Car insurance companies operate to make money, and they do this by reducing their risks to the lowest level possible. People who have bad credit are viewed as high risk, and statistically, individuals with bad credit seem more likely to drive poorly and submit insurance claims than those with good credit. To offset high risk, insurance companies charge higher insurance premiums to drivers with bad credit, whenever the law allows them to do so. Insurance laws vary by state, with most states allowing insurance companies to use credit history as a determining factor in insurance premiums. For this reason, it is wise for consumers to know their credit scores, and work to improve their credit ratings.
A process that takes a variety of factors into account determines an individual’s credit score. The three major credit rating agencies, TransUnion, Equifax and Experian, collect credit history data and calculate the scores. Credit scores were designed by the Fair Isaac Corporation, from which the name FICO was taken. The FICO score is considered standard in the industry, and an individual’s FICO scores from the top three rating agencies are usually looked at together.
It is important and helpful for consumers to understand how insurers look at credit scores. FICO changed and updated its system in 2008, revising the importance placed on certain items on a credit report. Collections for smaller dollar amounts of less than $100 receive less weight. A positive credit history with one repossession or closed account will not receive the same heavy judgment as the same event with other poor marks on the credit history. Having a diverse credit history provides for a better credit score, especially for individuals with different types of loans such as car, mortgage, personal or student loans, in addition to credit cards.
The new FICO credit scoring many have had a negative impact on some individuals’ credit histories, such as lower scores that result from having smaller amounts of available credit. For people who tend to max out their credit cards, this activity creates a negative influence on a person’s credit report and he is likely to see lower scores because of it. Additionally, closing credit accounts once they are paid off, while tempting, actually hurts people’s credit scores because it reduces their amount of available credit.
One thing that comes as a surprise to some people is that their credit score is different with each of the three main credit agencies. Even though the agencies all stick to a standardized FICO model, each agency has also developed its own precise methods for evaluating an individual’s credit history and calculating his credit score. Although the scores will most likely be different, they usually fall within the same category of credit worthiness.
The best credit score a consumer can expect will be in the high 700s. A perfect score is 850, which is an extremely rare occurrence. Any credit scores in the mid-to high 700 range are considered excellent, and scores in the low-700 range are considered very good. Scores considered good to average fall in the range of 680 to 699, while 620 to 679 represents the acceptable range of scores. In this range, consumers will still be able to get credit easily, although they will not receive the best or lowest interest rates.
When credit scores get into the range of 580 to 620, consumers are considered a credit risk. This range of scores is on the brink of the bad credit scores, which range from 500 to 579. The absolute lowest credit score is 300. Any score lower than 500 should prompt individuals to get professional help immediately to improve their rating.
Get Lower Car Insurance Rates, Even With Bad Credit
If an individual lives in a state that factors bad credit into its insurance pricing models, not many low cost insurance options are available. Most insurance companies, while having slightly different internal models for calculating premiums, will still factor in a bad credit history and provide consistently high quotes.
The first way to get lower rates is to apply some persistence, and start shopping around to as many insurance companies as possible. Some insurance companies specialize in high-risk drivers, which usually means a poor driving history. However, these types of insurers may be able to offer better prices for a driver who is considered high risk because of poor credit as well.
Next, consider every possible discount insurance companies offer. It might make sense to spend money up front for an advanced driving school program for example, in order to save a substantial amount of money on annual car insurance. It may also make sense to move a homeowner’s insurance policy to a new company and bundle it with car insurance to bring rates down with a bulk insurance discount. Other discounts exist, such as good driver discounts, multi-policy discounts, multi-car discounts and credits for accident-free driving over time.
Also important is work to improve upon existing credit scores. The easiest way is to pay down some debt, and pay only cash for items while avoiding the use of credit cards until balances come down. Keep in mind one of the goals, which is to get each card balance down way below its credit limit, since the more available credit a person has, the more beneficial this is to his credit score. Once a credit card is paid off, keep the account open and remove the card to a safe place, where it will stay only to be used in emergencies.
It is true that car insurance rates are higher based on a bad credit history. With diligent efforts put into shopping for a good policy, along with taking advantage of all possible discounts, lower premiums may be available. Making an earnest effort to reduce outstanding debt and improve credit scores can also go a long way in ensuring cheaper car insurance premiums in the future.