The likelihood of a major accident or disaster occurring in a particular home is the same regardless of whether the owner has a perfect credit score or is in the lowest subprime category.
So you may be surprised to learn that credit plays a big role in how much Americans pay to insure a home.
In most of the country, companies can use credit to price homeowners insurance – and the vast majority of insurers take advantage of it. With a bad credit score, new research shows you should expect to pay a lot more in premiums.
In states that do not limit the use of credit in insurance pricing, homeowners with FICO credit scores below 580 pay an average of 35% more for their premiums than consumers with scores between 740 and 799, according to the Matic insurance company.
In the few states that restrict the practice, Matic still found different prices 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 restricted states and $496 in unrestricted states.
Because insurance companies care about your credit
Lee Maliniak, chief product officer at Matic, says insurance companies charge higher premiums to customers with worse credit because they are more likely to file claims.
This has been confirmed by independent research, including a 2007 study by the Federal Trade Commission. But the reasons are not well documented and insurance companies usually don’t offer an explanation, Maliniak says.
“It may border on some sensitive socioeconomic and demographic topics that I don’t think anyone wants to be on the wrong side of,” he says.
One reason may be that filing a home insurance claim usually increases your premium, which policyholders typically try to avoid if they have the means to pay for repairs out of pocket. According to Insure.com, the typical premium increase ranges from 17% to 29%, depending on the exact type of claim.
Or, if your credit score is low, it could mean you have revolving debt or are behind on bill payments, which means it may be impossible to afford home repairs without going through insurance. “Maybe you are more likely to make a complaint because you Need file a complaint,” says Maliniak. “So I think there are many reasons like that, but most operators are not opposed to it. They will simply say that the math speaks for itself: it’s true [credit] it is predictive of the propensity to file a complaint and therefore we will price accordingly.”
How do insurance companies evaluate your credit?
Insurance companies use so-called credit-based insurance scores for underwriting and pricing.
These scores are technically different from those used by lenders for lending decisions, although they are based on the same type of information, says Christina Roman, manager of consumer education and advocacy for Experian.
“Traditional consumer credit scores help lenders evaluate a consumer’s ability to repay a loan or line of credit, while a credit-based insurance score helps home insurers determine the likelihood of a consumer having a insurance claim,” he says.
Credit-based insurance scores are based on information in consumers’ credit files, including:
- Payment history
- Debt owed
- Length of credit history
- Recent credit activity
Factors are weighted slightly differently in calculating insurance scores, which are offered by multiple companies. FICO, for example, places a slightly greater weight on payment history in calculating your credit-based insurance score than it does on a traditional credit score. Another change: These scores typically max out at 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’ll need to follow many of the same steps you would to improve your credit score, such as making payments on time and minimizing debt.
“It becomes an ethical debate”
In 2002, Maryland became the first state to enact a law limiting the use of credit scores in home insurance pricing. A handful of states followed in subsequent years, including California, Michigan, Massachusetts and Oregon.
Consumer advocacy groups have long argued that factoring credit into 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 more a year in insurance doubles the burden, advocates say.
On the other hand, insurance companies have lobbied against state bans on the practice, arguing that considering credit allows them to appropriately set prices based on the level of risk they are taking on.
Maliniak says he’s grappling with the question of whether it’s good policy to let home insurance companies set prices based on credit.
People with lower credit pay more because they are more likely to file a claim that the insurance company will have to pay, he says. “Now, is that right? This is where I think it becomes an ethical debate… It’s good to be accurate in terms of assessment, and it makes statistical sense for that to be the case, but it can also hurt the people who perhaps need the most help.
More from Money:
7 Best Homeowners Insurance Companies
How to Find Affordable Homeowners Insurance in 2024
Here are the 10 most expensive states for home insurance