You may not realize that your credit score can affect your insurance rates. Not only can a great score help you get a lower premium, but a bad one can factor into higher calculations. It pays to understand the relationship between the two and to work on lowering insurance costs by increasing your credit score.

The Correlation

Insurance companies consider your credit score to be a reflection of your financial habit and, therefore, how risky it would be to insure you. Just as banks are hesitant to loan money to people who represent higher credit risks, insurance companies are hesitant to give lower rates to people who may be less likely to pay their premiums on time, if at all.

To ensure their continued profitability, insurers hedge the risk of selling insurance to policyholders with low credit scores by charging them higher premiums (to learn more about the importance of insurers collecting sufficient premiums, see How to Choose an Insurance Company That Won't Go Out of Business).

And it's not just financial worries that are associated with a lower credit score; credit scores are correlated with other behavior that increases the risk for insurers. For example, a 2003 study from the University of Texas found that drivers with a higher credit score were less likely to be involved in car accidents or other events that would require filing an insurance claim. Of course, it's not clear what the cause is behind the correlation. Perhaps people who earn a higher credit score tend to be more responsible in general, which translates to safer driving. Or it might simply be that those with financial struggles have higher stress, which causes them to be more distracted on the road. But whatever the cause, the outcome is the same for the insurance company: an increased likelihood of paying out a claim.

Other Factors That Affect Insurance Rates

Credit scores are just one of many variables that factor into an insurance company's underwriting. When you apply for auto insurance, the company will perform a number of statistical measures that take into account your age, sex, the type of car you drive, how often you drive and at what distance, and so on (see The Top 5 Factors That Affect Your Auto Insurance Premium for more details). Health and life insurance companies will also put a great emphasis on your health habits, medical history, and age (find out What Influences Life Insurance Premiums).

Although credit scores are just one of many factors considered, you shouldn't treat them just like a drop in the bucket. A poor credit score can have a noticeable effect on your premiums. Even usage-based insurance policies might have to reflect the risk that a policyholder with a low credit score might fail to pay on time (see An Intro to Usage-Based Auto Insurance and Telematics to learn more).

Your credit score is also one of the few considerations that policyholders can have control over. While you can't do anything about your age or pre-existing medical conditions, you might be able to take steps to improve your score and lower your premiums.

How to Improve Your Credit Score

So, just how can you keep a healthy credit score? Here are a few helpful measures you can take:

  • Avoid defaulting on payments. Doing so can significantly lower your credit score.
  • Use a day planner, calendar, to-do list, or any other organizational method that suits you to keep your finances on track.
  • Set up automatic payments for recurring bills, and immediately pay one-time or less frequent bills as soon as you receive them.
  • Do not cancel credit cards you don't use. While you might feel that canceling the cards will seem financially responsible or look like you carry less debt, it could actually hurt your credit score. A better option is to manage your credit cards responsibly, which can include simply not using one of them.

Conclusion

No matter what kind of insurance you have, keeping your credit score as high as you can will help lower your monthly costs. With better credit and lower monthly expenses, you will be on your way to improve financial health.