Does your credit score affect your car insurance rate?

Many U.S. auto insurance companies use credit-based insurance scores to help determine risk when providing insurance quotes. (Unless you live in Massachusetts, Hawaii or California, where the practice has been banned.) Here's what you need to know about how insurers use credit scoring to help develop auto insurance rates:

Credit scores, or FICO scores, are based on information from your credit report and are used by lending institutions to determine how likely it is that you'll repay a loan on time. Credit scores are used in the determination of interest rates and loan qualifications.

Credit-based insurance scores, on the other hand, do not assess the likelihood that you’ll repay a loan on time. According to the Insurance Information Institute (III), credit-based insurance scores don't factor in your job, income history, gender or any other personal information. The III says they use factors like your payment history and the length of your credit history to assess your insurance risk level. Car insurance companies use them to help determine the likelihood of an insurance claim in the future.

How credit-based insurance scores work

Most U.S. insurance companies use credit-based insurance scores along with your driving history, claims history and many other factors to establish eligibility for payment plans and to help determine insurance rates. (Again, except in California, Hawaii and Massachusetts).

According to the III, if you have a better credit-based insurance score, an excellent driving history, and zero claims on your record, you'll typically qualify for lower rates. This score is only one of many factors used to calculate your premium. If you have an excellent insurance score but a less-than-stellar driving history, you might be considered riskier to insure.

Why insurance companies use credit-based insurance scores

Research shows that credit-based insurance scores can accurately predict insurance loss potential. Statistical analysis shows that those with worse insurance score are more likely to file a claim. Those with better credit scores tend to get into fewer accidents and cost insurance companies less than their worse-scoring counterparts. The Federal Trade Commission undertook an independent study to understand the relationship between credit history and risk. Their study, like others before, found that credit-based insurance scores are effective predictors of risk.

There are two types of credit inquiries, according to the Consumer Financial Protection Bureau (CFPB), hard inquiries and soft inquiries.

Hard inquiries

When you apply for credit, inquiries by lenders appear on your credit report. These credit checks, known as hard inquiries, may affect your credit-based insurance score

Soft inquiries

When your credit report is reviewed by you, by lenders reviewing existing accounts or by prospective lenders for pre-screening, it is noted as a soft inquiry. The consumer can see these inquiries on their credit report, but no other company can see them. Consequently, these will not affect your credit-based insurance score.

Favorable factors

• Long-established credit history
• No late payments or past-due accounts
• Open accounts in good standing

Unfavorable factors

• Past-due payments
• Accounts in collection
• A high amount of debt compared to the amount of credit available
• A short credit history
• A high number of credit inquiries

You can obtain your credit report through TransUnion or LexisNexis and dispute any unwarranted entries. Insurance companies aren't permitted to make any adjustments to your credit report, but will recalculate your credit-based insurance score if information from your credit report is corrected.

The Fair Credit Reporting Act (FCRA) gives you the right to obtain your credit report for free. If you notice inaccurate information, you have the right to contest it and correct your credit history.

The Fair Credit Reporting Act allows consumers to get a free copy of their credit reports every 12 months, according to the Federal Trade Commission. To monitor inquiries and guard against identity theft, the FTC recommends requesting and reviewing your credit reports from the three major credit bureaus (Equifax, Experian and TransUnion) each year. You can request your credit report at annualcreditreport.com.

Experian points out that seeing hard inquiries you don't recognize doesn't always mean identity theft. When you are shopping for things like a car loan or mortgage, lenders often send your information to more than one company to try to find the best terms. These companies, and often their abbreviated names or parent companies, will appear on your report, says Experian. If you're unsure of why your report was accessed, call the company directly.

When you see an inquiry on your credit report from a business you don't recognize or you aren't in the process of applying for a major loan, it could be a sign of credit fraud, according to Experian. Finding inquiries for services you haven't applied for may mean someone is applying for credit under your identity.

If you suspect you're a victim of identity theft, the FTC recommends taking immediate action and following these steps:

1. Put a fraud alert on your credit report by calling one of the three major credit bureaus. This lasts 90 days, is free to do and the bureau you call will alert the other two. When a fraud alert is attached to your report, lenders and businesses have to take extra steps to verify your identity before offering credit.
2. Contact businesses related to suspicious inquiries or affected accounts. The FTC advises that you ask for receipts and keep records of all communication with these companies.
3. Submit an identity theft affidavit to the FTC. Use the affidavit report to file a police report ━ and keep a copy. The affidavit and the police report together make up an identity theft report, which can help you remedy the situation with the credit reporting companies, debt collectors and businesses that may have given credit to the thief.