What do your credit cards and auto insurance policy have to do with each other? According to the Federal Trade Commission, a lot. In 2007, they conducted a study that showed a correlation between drivers' credit scores and insurance claims. Drivers with lower credit scores had more auto insurance claims than those with higher scores. Insurers use this study, along with several other studies cited by the FTC, to justify basing auto insurance premiums on drivers' credit scores. You can use the knowledge to lower your auto insurance premium by paying off your credit cards.
Credit-Based Insurance Scores
The vast majority of insurance companies consider drivers' credit scores when underwriting policies. Citing a figure from the Fair Isaac Corporation (FICO), the National Association of Insurance Commissioners (NAIC) estimates that as many as 95 percent of insurers use a credit-based insurance score in states that permit it. (Massachusetts, Hawaii and California have banned the practice.)
Several factors affect your credit-based insurance score. Your credit score is one of them. Improving your credit score will improve your insurance score, which will lead to lower car insurance premiums.
Your credit score is a number that represents how reliable your credit history is. Investopedia lists five factors that directly affect the number:
- payment history
- amounts owed
- length of credit history
- new credit
- types of credit
Of these, your payment history and amounts owed have the greatest impact on your credit score. Combined, they account for 65 percent of your score.
Paying off your credit cards' balances will significantly improve both your payment history and amounts owed.
When looking at your payments history, creditors want to see that you pay your bills on time. Each time you are late on a credit card payment counts as a strike against you. If you are not currently paying at least the minimum amount due on each card, you are not just racking up late fees. Your failure to pay on time is also being reported and affecting your credit score. Even if you cannot pay off an entire credit card, beginning to pay the monthly minimum will have a positive effect on your score.
Amounts owed is a ratio of your current debt levels to your available credit. Only using a small percentage of your available financing is better than maxing out all your available lines of credit.
Paying down credit card balances is one of the quickest ways to improve your amounts owed. As an example, assume you have a $100,000 mortgage and a balance of $10,000 on a credit card. You also have $1,000 to pay off debt with. Putting that money toward your mortgage will only improve its debt-to-credit ratio by 1 percent. Paying off $1,000 of your credit card, in contrast, will improve your card's amounts owed ratio by 10 percent. Ultimately, it is best to pay both down, but starting with the credit card will more quickly impact on your credit score.
Car Insurance Premiums
When you pay down your credit cards and improve your credit score, car insurance companies will consider you a safer driver. They will reward you with lower premiums. While a reduction in your auto insurance premiums may seem small compared to how much you will save in credit card interest, every little saving helps. If improving your financial health will earn you better auto insurance premiums, you might as well take advantage.
Why not start today? Begin paying off your credit cards little by little with any extra cash you have. After a couple of months, compare quotes on new car insurance policies and see if you qualify for lower premiums than you currently have.
For more information on lowering your insurance costs, contact a local agency, like Preferred Insurance.