Having poor credit means paying more to borrow money or not being able to afford a purchase altogether, but that’s not the only detrimental effect. In many states, insurers may charge you more for your home or auto insurance if you have a low score.
Lawmakers in four states want to stop the practice as rising prices strain the budgets of drivers and homeowners. Ppeople with low scores end up paying more – often too much – which consumer groups say is unfair and unfair.
Data from online insurance platform Insurify finds that drivers with bad credit pay 40% more for their auto insurance; in some states, that gap is as wide as 60%. This can add up to more than $1,000 a year for drivers with checkered credit histories.
The Consumer Federation of America, a consumer advocacy group, documented an even wider gap: In a 2023 paper, the group found that drivers with bad credit tend to pay nearly twice as much on their auto insurance.
There is also a significant, though not steep, correlation between credit quality and home insurance premiums. Annual homeowners insurance premiums are up 7% from last year, with the average homeowner now paying about $200 a month or $2,400 a year.
An NBER research paper found that homeowners with poor credit pay about 25% more for their performance than homeowners with excellent credit. While living in a disaster-prone area can mean higher premiums, the NBER found that homeowners’ credit scores were as much a factor as home location.
It’s a common practice, but the unintended consequences are increasing
Currently, only a few states prohibit the use of credit data in setting premiums. California and Massachusetts prohibit using credit data to determine homeowner or auto premiums; Hawaii covers it with home insurance, and Maryland bans it with car insurance.
Lawmakers in several other states want to tighten the practice, too. Bills have been introduced in state houses in Iowa, New York, Oklahoma and Pennsylvania that would restrict insurers from using credit data in setting home and auto insurance rates.
“Our state laws must protect consumers… as we work to make insurance more affordable and fair for all Oklahomans,” state attorney Julia Kirt said in a press release announcing the law, one of three bills targeting high insurance costs.
“This practice has many unintended consequences,” Michael DeLong, research and advocacy associate at the Consumer Federation of America, tells Money via email. “It makes it harder for Black and Latino consumers to get help, and harder for low-income homeowners to get help, as they all tend to have shorter credit histories and lower credit scores.”
From there, the problems can multiply, DeLong says: People who can’t afford car insurance risk getting into legal trouble if they’re caught driving without it, while the associated fines and costs add to the economy. The impact on prospective homeowners is subtle, but more damaging in the long run, because mortgage lenders require borrowers to carry homeowners insurance.
“They can’t own homes, which makes it very difficult for them to build wealth and assets,” DeLong noted.
Industry experts argue that credit data helps insurance companies do a better job of assessing risk and charging accordingly. Bob Passmore, vice president of the personal lines department of the American Property Casualty Insurance Association, an insurance trade group, told CNBC that credit scores “assess a person’s risk fairly and accurately.”
And to be sure, using an underwriting model that includes credit data doesn’t hurt everyone: A 2007 FTC study on auto insurance found that credit data entry can lead to lower payments for nearly 60% of drivers, and higher premiums for the rest.
An NBER paper looking at links between credit and home insurance prices found that people with low credit scores were more likely to apply after their home was damaged. Researchers suggested that this is because these homeowners may not be able to borrow money to repair themselves after a disaster. “Applying may be the cheapest, if not the only, way to cover unavoidable costs immediately,” they wrote.
Consumer advocates say this is proof that using credit data can unfairly punish people for financial situations that may not be their fault.
But given its prevalence — for now, at least — in insurance underwriting across the country, homeowners and drivers tired of sticker shock should use the tools at their disposal.
“Improve your credit score, because that will lower your premium,” advises DeLong. By getting a high credit score, you can buy the best car insurance and the best home insurance rates.
“Don’t hesitate to switch insurance companies,” DeLong says, and ask if you can get discounts for things like signing up for paperless statements or paying premiums in advance.
More from Mali:
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