How Your Credit Score Affects Your Insurance Premiums

Do you want a lower car insurance premium? You can with an improved credit score and get affordable car insurance. It begins with knowing which levers to touch to improve your credit score. With this article, 1st for Women aims to shed light on all the important aspects of credit scores. You will learn about what a credit score is and discover what a good one is and why it’s important when getting insurance.

What is a credit score, and why is it important?

Have you ever been denied a credit card or a loan? Has your bank ever declined to increase your credit card limit? If you answered yes to any of these questions, the reason is probably a lower credit score.

A credit score is a three-digit number that estimates the likelihood of paying back credit taken from financial institutions. Lenders use it to gauge your creditworthiness and estimate your risk as a borrower. Your credit score is in your credit report, a record of all your credit accounts, payment history, new credit inquiries and other details.

There are a couple of credit-scoring methods, of which the most popular is FICO[1]. This scoring model, like the rest, uses your credit report information to calculate your credit score. FICO scores range from 300 to 850, with lower scores indicating a high probability of defaulting and higher scores suggesting that you are a  reliable payer.

The information in your credit report originates from lenders who send your payment record to credit bureaus. The four main credit bureaus in South Africa are TransUnion, Compuscan, Experian and Xpert Decision System (XDS).

Each credit bureau sends borrowers’ payment records to these credit bureaus every 45 days. It’s from that information that your credit score is calculated. You are entitled to one free credit report from each credit bureau annually.

It’s not only lenders who use credit scores. Landlords, employers, and insurance companies use them. For instance, insurance companies can use them and other factors to figure out your insurance premium.

Without a credit score, it would be hard to access many financial products. For instance, you can’t get a credit card and may desperately need to handle a financial emergency such as hospitalising your loved one.

If you want a credit score, all you need to do is open a couple of credit accounts. Opening these accounts is important when you can use credit responsibly because misuse could ruin all aspects of your financial life.

You don’t just want to have a credit score. It must be a good one. And what is a good credit score? It depends on the scoring model being used. In the case of FICO, a credit score higher than 700 is considered good, while 800 or more is excellent. The higher the credit score, the better the credit terms you are likely to receive.

Credit score and insurance: do you need a credit score to get insurance?

Yes and no. A credit score is related to your insurance. A low credit score may lead to higher insurance rates or premiums. If you default on your insurance premiums, your credit score may receive a hit.

Insurance companies gauge how risky you are to insure by including your credit score among the factors to calculate your risk factor and insurance premiums. For instance, when you apply for car insurance, the insurance company will look at your age, where you park the car at night, your claims record, your driving experience, and your credit record to come to an insurance premium.

Insurers look at your credit score to help them understand how risky you are to them. It follows that having a good credit score will help you get better insurance premiums. This would save you hundreds of rand over the period of a year. You could use those savings to add to your investments or other purposes.

Why is a credit score used for insurance premiums?

Companies like FICO and LexisNexis calculate credit-based insurance scores and normal credit scores. However, these insurance scores rely heavily on your credit report. As a result, the factors that impact your credit score will also influence your insurance score.

Does credit score affect car insurance? Let’s answer that question this way: say that you recently made a couple of late payments on one or two of your credit accounts. The next time you check your credit record, you will find your credit score has taken a knock. If you apply for insurance such as auto insurance, you’re likely to pay higher premiums. And if you had to apply for insurance, you may be denied if your credit score is poor. 

To assess your risk, insurance companies evaluate the same factors as lenders, including:

• Hard inquiries: When you apply for credit, lenders perform hard enquiries or credit checks on your credit report. The more of these enquiries lenders make, the harder your credit score gets knocked down. Most importantly, frequent hard enquiries suggest you’re not on top of your finances.

• Payment history: This is a huge factor on the credit score calculation. It tells the lender how well you’ve made payments in the past. Lenders will look for missed payments and whether you pay timely or late.

• Amount of available credit you use: This is called credit utilisation rate. The more available credit you use, the harder it can be to stay up to speed with your payments. Hence, a high utilisation rate may lead to higher insurance premiums.

• Average length of your credit: This is the average age of your credit accounts. The longer it is, the more favourable you look in the eyes of insurers.

• Types of credit accounts: A variety of credit accounts and a good payment history suggest you have a good grasp of credit. As a result, you could be treated favourably by insurance companies.

6 ways to improve your credit score & reduce insurance premiums

Since your credit score influences your insurance premiums, improving it can reduce them. There are proven approaches to this, including the following:

1. Keep your payment history up-to-date: If you’ve never made late or missed any payment, keep it up. However, you can still reclaim and improve your credit score if you make timely payments and never miss payments. This will go a long way towards improving your credit score because this factor greatly influences it.

2. Reduce your credit card balances: Doing this will reduce the amount of credit you have used and drop your credit utilisation rate. As a result, your credit score will receive a boost.

3. Keep old credit accounts open: Older accounts increase the average age of your credit history. The older the average age of your accounts, the better your credit score if all the other factors are good.

4. Limit new credit applications: A hard enquiry causes a drop in your credit score. Doing many credit applications within a short period greatly hurts your credit score. When you limit making new credit applications, there will be fewer hard enquiries, and your credit score will stay strong.

5. Check your credit report for errors and rectify any mistakes: Lenders can send wrong credit information to credit bureaus. For instance, they may mistakenly claim you missed making a payment and get a hit on your credit score. Checking your credit report regularly can minimise errors like this and more.

6. Use a credit monitoring service: identity theft is real and can go undetected for months to years, according to TransUnion[2]. Signing up for credit monitoring service can prevent it from damaging your credit. When someone uses your identity to apply for credit, you’ll receive an alert and act timely.

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Sources:

[1] FICO.com 

[2] TransUnion.co.za 

Disclaimer: The information in this article is provided for informational purposes only and should not be construed as financial, legal, or medical advice.