Your credit history plays an important role in almost all things financial. It’s either a propellor or an anchor that affects not only your rates and costs but your ability to buy things, including your homeowners insurance.
Chances are your credit score has already affected your home’s mortgage rate. The same likely goes for homeowners insurance. Insurance companies often check your credit information to set the rate. This analysis results in your credit-based insurance (CBI) score, which is similar to a FICO credit score.
This CBI score is calculated differently depending on the insurer. It can vary greatly by state, either affecting your rate minimally, not at all or more than 30%.
A few states don't allow insurers to use consumer credit information to determine a rate or premium:
- California, Massachusetts and Hawaii don’t allow this for auto insurance.
- Maryland and Hawaii don’t allow it for homeowners insurance.
In other states, insurers must alert you when your credit history affects your home insurance. For instance, the Fair Credit Reporting Act (FCRA) Adverse Action Notification "requires any user of a credit report to notify the consumer if the use of that report resulted in an adverse action, which, in the case of insurance, would be a denial of coverage or a higher premium than a consumer with an average insurance credit score."
Loretta Worters, vice president of media relations for the Insurance Information Institute (III), said every insurer weight credit differently.
"Just as insurance scores help insurance companies assess and price risks, so too can these scores help insurance customers -- particularly if they are considered good risks. Depending on the company and state, roughly 50% of policyholders can pay lower premiums because of good credit,” Worters said.
Worters referenced a 2017 report from the Arkansas Insurance Department. A review of 3.4 million personal lines policies found that more than half of saw lower premiums because of credit history. Only 20% saw a rate increase because of their credit. One-quarter of policies didn’t see any impact on rates.
Worters added that credit score was more likely to increase auto premiums than home (24% of auto policies compared to 17% of home policies).
How does credit history influence home insurance costs?
That CBI score is often just referred to as an "insurance score.” As with a FICO score, CBI is a collection of financial factors that determines your overall credit stability, but on the terms of the insurance company. In other words, it’s based on what they care about related to your credit and how it pertains to home insurance. Insurers vary their formulas to determine this.
"Many property and casualty insurance companies find that consumer credit information correlates with future losses," said Kevin Haney, who owns A.S.K. Benefit Solutions and has more than a decade of experience with Experian, one of the "big three" consumer credit reporting agencies. "In other words, the data improves their ability to forecast how prospect and customer segments will behave over time."
Here’s what can positively affect your score:
- Long credit history
- Low credit usage
- Good standing at your banks and credit accounts
- Paying on time
"Insurers look at your financial behavior -- like how frequently you've had late or missed bill payments and how much debt you have -- to generate your credit-based insurance (CBI) score," said Worters.
Policies vary signficantly between insurance companies. That includes how often a company checks your credit. Many pull a credit check when you're a new applicant, or when you are renewing a policy. Most carriers also adhere to regulatory requirements, running a check when it’s mandatory. Again, these requirements vary by state, too.
"Every insurance company employs a different risk underwriting strategy for how and when they use credit information," said Haney. "Some may look at your file each time they price policies for new customers and renewals. Others may do so after a claim."
John Espenschied, owner of Insurance Brokers Group, said some insurers run credit numbers every three to five years.
"We've seen companies sometimes take very large rate increases for no particular reason that anyone can explain," said Espenschied. "The problem is no insurance company will reveal the black box they use to determine what credit score equals what premium."
How does a bad credit history increase home insurance rates?
Filing claims can cause your home insurance rates to skyrocket. For instance, two fire claims, or two liability claims or two theft claims will increase rates between 38% and 44%, according to our recent analysis.
What could actually might make rates jump even higher than that? You guessed it: bad credit.
The national average percentage increase for homeowners with bad credit is 127% more than those with excellent credit. That translates into about $1,700 more annually.
"When data analytics find that people with a history of late payments are more likely to file a home insurance claim, the issuing company may charge a higher rate to offset the greater risk,” said Haney.
"Every insurance company employs unique underwriting strategies," he added. "Also, homeowner claims have different causes and costs. For example, wind and hail damage is a function of bad weather, while a liability claim could be related to neglect by the owner. "
Even if your credit falls into the "fair" category, it'll affect your insurance in much the same way as a "C" on your report card affects your chances of getting into a certain college or university. With that middle-of-the-road credit, you'll get slapped with an average of 34% (or $425) more than those with shiny, gold-star credit. Homeowners in Tennessee and South Dakota with fair credit pay roughly 70% more on average than those with excellent credit.
"Insurers also consider your prior insurance loss history, the construction type of your home, the distance of your home from fire hydrants and fire stations, and whether or not you have smoke detectors, fire alarms and a security alarm in your home," reminded Worters.
Why do insurers care about a person's credit history?
The reason for such widespread adoption of insurance scores for underwriting and rating is that studies show a strong correlation between insurance scores and losses. Worters pointed to a study published in 1996 by Tillinghast, an actuarial consulting firm, that showed a "highly statistically significant" correlation between insurance scores and loss ratio, which is the cost of claims filed relative to the premium dollars collected.
"In other words, people who have low insurance scores, as a group, account for a high proportion of the dollars paid out in claims," said Worters.
A subsequent study published in 2003 in the Casualty Actuarial Society Forum came to similar conclusions: "From a statistical and actuarial point of view, it seems to us that the matter is settled: credit does bear a real relationship to insurance losses."
Studies maintain that people who manage their finances well tend to also manage other important aspects of their lives responsibly, such as maintaining their home or making routine repairs. Insurance companies like to see this.
"Someone who has over-leveraged themselves (debt-to-income ratio), history of late pays, collections or loans in default is a much bigger risk in the eyes of the insurance companies," said Espenschied. "Someone who has kept low balances and shows a history of on-time payments is viewed as more responsible and a better risk for insurance."
What should you do if you have poor credit?
Your credit score is among the most important factors in differentiating rates between homeowners insurance companies, so as with all savvy shopping, you've got to compare and contrast.
"People with poor credit can improve their score and shop around for insurance," said Haney. "They can improve ratings by paying bills on time, reducing debt and disputing errors on their consumer report. They can get multiple homeowners insurance quotes because each issuing company performs underwriting differently. Getting an insurance quote results in a soft inquiry, which does not hurt your credit score."
If your credit isn't so hot, there are ways to improve it. Patience and diligence are key, so take it step by step, and those points can rise. Here are several tips courtesy of III:
- Pay your bills on time.
- If you missed payments, get current and stay current.
- If you’re having trouble making ends meet, contact your creditors or see a legitimate credit counselor.
- Keep balances low on credit cards and other "revolving credit."
- Pay off debt. Don’t just move it around.
- Don't close unused credit cards as a short-term strategy to raise your score.
- Don't open new credit cards that you don't need.
- Open new accounts with due diligence.
- Re-establish your credit history if you have had problems. Opening new accounts responsibly and paying them off on time will raise your score in the long term.
Espenschied echoed that the best advice for those with poor credit, besides shopping around for lower homeowners insurance, is to tackle that debt.
"In most cases, lenders just want to be paid back and are willing to work with you, which means they might not report continual late payments if you can make a solid arrangement,” Espenschied said.