Americans With Bad Credit Pay 35% More for Home Insurance

The likelihood of a major accident or disaster happening to a particular home is the same regardless of whether the owner has a perfect credit score or if they’re in the lowest subprime category.

So you might be surprised to learn that credit plays a major role in how much Americans pay to insure a home.

In most of the country, companies are allowed to use credit in determining homeowners insurance pricing — and the vast majority of insurers take advantage. With a bad credit score, new research shows that you should expect to pay a lot more in premiums.

In states that do not restrict the use of credit in insurance pricing, homeowners with FICO credit scores below 580 pay 35% more on average for their premiums compared to consumers with scores between 740 and 799, according to insurance firm Matic.

In the handful of states that limit the practice, Matic still found different pricing based on credit, but the gap is much smaller: 15%. In dollar terms, the annual difference between premiums paid by those with 'poor' credit and those with 'very good' credit is $174 in states with restrictions and $496 in states without them.

Why insurance companies care about your credit

Lee Maliniak, Matic's chief product officer, says insurance companies charge higher premiums to customers with worse credit because they’re more likely to file claims.

That has been confirmed by independent research, including a 2007 study by the Federal Trade Commission. But the reasons aren't well documented, and insurance companies usually won’t offer up an explanation, Maliniak says.

“It could border on some sensitive topics of socioeconomic demographic things that I don't think anyone wants to be on the wrong side of," he says.

One reason could be that filing a home insurance claim usually causes your premium to go up, which is something policyholders typically try to avoid if they have the means to pay for repairs out of pocket. The typical premium increase ranges from 17% to 29%, depending on the exact type of claim, according to Insure.com.

Or, if your credit score is low, it could mean you have revolving debt or are behind on bill payments, meaning it may be impossible to afford home repairs without going through insurance. "Maybe you're more likely to make a claim because you need to make a claim,” Maliniak says. “So I think there's a lot of those kinds of reasons, but most carriers won't opine. They’ll simply say that the math speaks for itself — it's true that [credit] is predictive of propensity to file a claim and thus we’ll price accordingly.”

How do insurance companies assess your credit

Insurance companies use what are known as credit-based insurance scores for underwriting and price setting.

These scores are technically different from what lenders use for loan decisions, though they're based on the same type of information, says Christina Roman, consumer education and advocacy manager for Experian.

“Traditional consumer credit scores help lenders assess a consumer’s ability to repay a loan or line of credit, while a credit-based insurance score helps home insurers determine the likelihood that a consumer is going to file an insurance claim," she says.

Credit-based insurance scores are based on information in consumers’ credit files, including:

• Payment history
• Debt owed
• Credit history length
• Recent credit activity

The factors are weighed slightly differently when calculating insurance scores, which are offered by multiple companies. FICO, for one, puts a bit more weight on payment history in calculating its credit-based insurance score than it does with its traditional credit score. Another change: These scores typically max out higher than 850, which is the highest standard credit score. For example, the highest possible FICO insurance score is 900.

Differences aside, to improve your credit-based insurance score, you will need to follow many of the same steps you’d take to improve your credit score, like making payments on time and minimizing debts.

'It becomes an ethical debate’

In 2002, Maryland was the first first state to enact a law restricting the use of credit scores in home insurance pricing. A handful of states, including California, Michigan, Massachusetts and Oregon, followed in the years after.

Consumer advocate groups have long argued that considering credit in insurance decisions makes homeownership even more expensive for those who can least afford it. Homeowners with lower credit scores typically have higher mortgage rates. Paying hundreds of dollars extra per year in insurance doubles the burden, advocates say.

On the other side, insurance companies have lobbied against state bans on the practice, arguing that looking at credit allows them to appropriately set prices based on the level of risk they're taking on.

Maliniak says he grapples with whether it's good policy to let home insurance companies price based on credit.

People with lower credit pay more because they're more likely to file a claim that the insurance company will have to pay out, he says. “Now, is that fair? This is where I think it becomes an ethical debate… It's good to be accurate in terms of rating, and it makes sense statistically that it is the way it is, but it can also hurt people who maybe need help the most.”

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