If you haven’t checked your FICO score (the credit score banks and lenders see) lately, you might want to later this year. The three digits that hold the key to your financial life might be a bit higher than you expect.
The Fair Isaac Corporation (FICO), creator of the FICO score, the number most widely used by banks and lenders to determine a person’s creditworthiness (not the “free” consumer credit score available via many websites and services – see Top Places To Get A Free Credit Score Or Report ) is rolling out a new scoring model. Its formula offers hope to consumers whose credit reports contain certain types of negative information.
Currently, lenders are using FICO 8, a scoring model that equally factors in paid and unpaid collection-agency accounts that exceed $100. Unpaid and paid collections under $100 are already ignored in FICO 8 scoring.
Beginning in September 2014, FICO® Score 9 will be released to the three credit bureaus – Experian, TransUnion and Equifax – for them to test and validate, says Anthony Sprauve, senior consumer credit specialist, FICO and myFICO.com. Then they have to decide whether to adopt the new system, so it's not clear when (and where) the scoring changes will show up.
That new model will ignore unpaid and paid medical debt, which FICO now sees as not as indicative of whether a consumer will repay debts. It will also ignore collection accounts that have been paid.
FICO 9 also lets banks and lenders better assess the risk of consumers with limited credit history or “thin files.” While developing FICO 9, data scientists classified a consumer’s repayment behavior in degrees of risk instead of labeling a consumer as someone who paid or didn’t pay her bills in absolute terms. Sprauve says the end result is a score with an improved ability to assess the risk of thin files.
“Once testing is completed, the credit bureaus will make FICO 9 scores available to lenders starting later this year,” says Sprauve.
Lenders can decide when they want to begin using the new FICO 9 scores beginning in late 2014.
Big Potential Impact
Sprauve says there are 200 million adults in the U.S. with a credit report and FICO Score; 14% of consumers have a medical debt collection that exceeds $100; 17% of consumers have a non-medical debt collection that exceeds $100. “Those two groups are not mutually exclusive – a consumer can have both a medical and non-medical debt collection,” says Sprauve.
Very few of those accounts in collection are paid. “Ten percent of all collections are paid while 90% of all collections are unpaid,” he adds. “Of the unpaid collections, 53% are medical-debt–related.”
The Consumer Financial Protection Bureau (CFPB) found that unpaid medical bills were disproportionately affecting consumers’ credit scores. The new FICO 9 will now differentiate between collections from medical and non-medical debts, lowering the weighting medical debts have on a consumer’s FICO score and potentially positively affecting millions.
“Our research shows that for consumers whose only major derogatory in their credit report is unpaid medical debt, that it is not an indicator of their inability to repay their debts. This type of unpaid item is not as negative as a regular unpaid collection would be,” says Sprauve. “That’s why we adjusted the algorithm.”
Sprauve says the median FICO Score for consumers whose only major derogatory references are unpaid medical debts is expected to increase by 25 points. The results would be different if there are other debts, as well. “It is definitely possible that someone whose only credit blip stems from medical debt to see a bigger bump in their FICO score than someone with other credit issues combined with medical debt,” says Sprauve.
Changing View of Medical Debt
FICO 9 is part of a trend in debt evaluation. “This is nothing new,” says Joseph Lizio, CEO, Capital LookUp LLC, and a former commercial lender. Banks and lenders have been viewing medical debt differently from other defaults and late payments for some time.
“When a borrower (usually a business borrower) was on the fence of our minimum credit score threshold, we would go through that person’s credit report to see what the cause was. If we found a low score just because of a bad medical line item, we would argue that point with our credit committee and usually get them to waive the credit score issue,” says Lizio.
The thinking was that many consumers had some kind of medical past-due account on their credit histories. “This was in part due to insurance companies paying late or not at all. Thus the potential borrower was fighting both the insurance company and the medical biller as well as came about by the size of medical bills, forcing many people to get behind on their payments, much like student loans today,” says Lizio.
Experts say once FICO 9 scores take hold, Americans whose scores were weighed down by medical debt should consider reapplying for loans or trying for lower interest rates on credit cards and loans than they’ve previously been offered.
But keep in mind that getting that higher FICO score could backfire. "There could be a downside to unexpected bump in consumers’ FICO scores,” says Lizio. Consumers with a new, higher score might use that score to be approved for loans or credit cards they max out but can’t afford. “Removing any negative item from a credit report could raise that score, and if the raising is justified, [that’s] great,” says Lizio. “But it could lead to those who aren’t creditworthy being approved for credit they can’t handle.”
The damage is likely to be limited, though. These consumers won’t likely be approved for enormous mortgages, says Lizio, adding that they could get into financial trouble with smaller loans, such as auto loans or credit cards.
The Bottom Line
Whether your FICO score will rise due to the removal of medical debt or not, Lizio says that handling your score carefully is a smart move. Review each of your three credit reports annually to check for errors related to medical debt as well as other information, such as past-due accounts, balances, etc. And be sure to be mindful of your credit score. See Credit Report Alert! for more information.
Even though a higher FICO score may increase a consumer’s access to additional credit, it’s still the consumer’s responsibility to use that credit wisely, says Lizio.