Is bad credit a character flaw?

Housing: Unless you're renting from a friend, expect to produce a credit history. Apartment managers not only check for previous defaults but can look for prior addresses to compare with criminal background checks.

Auto and homeowners insurance: Almost all insurance companies incorporate credit history data into their underwriting, despite the objections of insurance-agent associations, which say the practice unfairly and illogically raises rates for struggling customers.

The credit bureaus and insurance companies say there's a correlation, backed by independent studies, between poor credit scores and an increased number of claims. But they admit that they have no idea why the pattern exists and can't prove that one causes the other. They say it's an added risk-management tool that ultimately allows insurers to reduce prices for other drivers.

"Our belief is that people who are careful and prudent in managing their finances are also careful and prudent in other areas of their lives," says Michael Gaughan, a vice president at TransUnion. "They're prudent and careful in how they manage one of the largest assets in their lives, their home, and in how they lock up and care for their vehicle."

It's not logical, and it doesn't work

Not everybody buys this argument, or the others.

"Credit scoring was bad for people in the beginning, and it is bad for people now," says Ralph Buchanan, director of legal activities for the United Farmers Agents Association, which opposes using credit history to price insurance. "Where is it fair if this husband and wife are making $10 an hour and scraping by to pay the bills and miss a couple bills? Why do they have to pay more for their auto insurance?"

It amounts to charging people for being poor, agrees Jim Fish, executive director of the National Association of Professional Allstate Agents. "It's a strange and crazy deal that these insurance companies have got going on."

"The question I have is: How do people ever get out of that cycle? If you're making it so expensive for them, how can they ever rise above that?" he says. "It's no wonder there are so many uninsured drivers out there."

Legislators in many states have introduced bills to prohibit the use of credit history in insurance underwriting. But very few states -- including Hawaii, California and Massachusetts -- currently prohibit the practice.

Credit scoring may have benefited insurers to the tune of $67 billion from 2003 to 2006, according to a 2007 study by the National Consumer Law Center.

In 11 states, legislators have restricted the use of credit history for employment. Many would like to see it banned altogether.

Credit scores are famously riddled with errors, with discrepancies of as much as 100 points among the bureaus. The reports don't reflect on-time payments to utility companies. Credit histories are routinely damaged when bad things happen to good people. And, most importantly, there simply isn't any evidence that people with heavy debt loads make bad employees or greater insurance risks.

Piper Hoffman, a partner at Outten & Golden, an employment law firm in New York, gets calls every month from workers at all income levels who have lost job offers after a credit check. Some had already been working on a temporary basis and were well-liked.

One man, an executive, had damaged his credit after taking out a second mortgage to pay his mother-in-law's medical bills. "And he found the job offer being withdrawn because essentially he was being a good son-in-law and taking care of his family," Hoffman says.

The assumption, she thinks, is that people with debt will embezzle funds, "which is another way of saying 'we don't trust poor people.' And there's no evidence of that."

In what appears to be the only definitive study on credit history and job performance -- it's difficult to get access to personnel data -- an Eastern Kentucky University professor found no correlation between the two. In fact, the only finding of any statistical significance was the opposite: The workers with poor credit history were more likely to work hard.

"I would be really worried if companies were making judgments about a person's character based on their credit report," says a study co-author, Jerry Palmer, an associate professor of industrial psychology. "I would not use them."

What can you do?

You don't have to consent to a credit check, but a company can legally reject you for employment or housing if you refuse.

"I don't know that there's a lot we peons can do to fight back, other than make sure your credit is in the best position. You get your credit report every year. You dispute any major items," says Weston, the personal-finance expert. "You want to create your credit file in as good a position as you can. And you want to build your score by using credit."

If there is a problem, add the permitted 100-word explanation to your credit report, and be upfront with people. Human-resources managers say they are sensitive to the fact that circumstances don't define a person in full.

If you believe a job denial based on credit qualifies as discrimination, file a complaint with the U.S. Equal Opportunity Employment Opportunity Commission or contact an attorney. Across the country, lawyers are trying to ban the practice.

It hasn't gotten into court yet, Hoffman says, "but I believe that once we get to that point, we will win."

Updated March 12, 2009

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