Some 64.3 million U.S. consumers who have at least one medical debt on their credit report woke up to a healthy dose of good news on Friday that the Fair Isaac Corp. (FICO) — which lenders use in 90 percent of their consumer and mortgage lending decisions — will penalize them less for their unpaid medical bills.
FICO further announced that it will stop including in its FICO credit-score calculations any record of a consumer failing to pay a bill if the bill has been paid or settled with a collection agency.
Why this is good news
The new FICO score rules will likely boost the credit scores for millions of Americans, giving them greater access to a wider range of loans, at a reduced interest rate.
“It’s been a long time coming,” said Ted Rood, a national mortgage lender based out of St. Louis, Mo. “This is going to be a game changer!”
“It’s wonderful, wonderful news,” said Gina Dale, a loan officer with Centrue Bank in Plano, Il. “So many more people will now be able to qualify for loans.”
The new scoring model will likely be implemented by credit-card and auto lenders first. Mortgages typically lag in adopting new scoring models.
Nevertheless, the new FICO score rules are set to ease access to borrowing for millions of consumers. Currently, collections can impact credit scores as much as foreclosures or bankruptcies do and stay on credit reports for seven years, even if a borrower has paid off that balance and remained current on other debts.
Why the change?
The relaxing of standards has been driven by multiple studies, including FICO’s own, showing that an unresolved medical debt caused by a medical emergency, was not as serious or negative as a regular unpaid collection.
In another study based on 5 million anonymous credit records, the Consumer Finance Protection Bureau in May criticized credit-scoring models for applying too much weight to unpaid medical debt.
Action was further prompted by the sharp increase in the number of Americans struggling with medical debt, which rose from 58 million in 2005 to 75 million people in 2012, or 41 percent of U.S. adults, the Commonwealth Fund stated in a report last year.
In announcing a loosening of its standards, FICO made it clear it was not overstating the creditworthiness of borrowers. Rather, it believes the new standards will more accurately reflect a borrower’s true credit risk and provide lenders with greater precision in their loan-making decisions. According to FICO, the median FICO score for consumers whose only major derogatory references are unpaid medical debts is expected to increase by 25 points.
Who else will benefit?
Consumers won’t be the only winners under the new model. FICO’s changes should also boost the sagging loan portfolios of lenders. With the new scoring changes, more Americans will be using mortgage calculators, like the one below, to calculate their mortgage payments:
“FICO Score 9 uses a more refined treatment of consumers with a limited credit history and those with accounts at collection agencies, so that lenders can grow their credit and loan portfolios more confidently,” said Jim Wehmann, a FICO executive vice president.
FICO’s new more lenient model should also benefit collection agencies. Consumers with unpaid medical debts now have an incentive to settle, knowing that FICO will stop including in its calculations any record of a consumer failing to pay a bill, if the bill has been paid or settled with a collection agency.
“This is great news for collection agencies,” Rood said. “It provides laggards with an incentive to pay up. Before these changes, you were incentivized not to pay off your debt. The last thing you wanted to do was trigger a new ‘date of last activity’ report for an old debt, say, a debt from 2008. Again, you were just better off not paying it because older debts weighed less heavily against you on your credit report than new debt.”
Amir Erez with Cedar Financial, a Calabasas, Calif., collection agency, doubts, however, that FICO’s new calculations will motivate deadbeats to pay up.
“I haven’t had enough time to really digest the news,” Erez said, “so at this point I remain very cautious. The reality is if you have a big debt to pay, you’re probably still not going to pay it unless you’re forced into litigation.”
FICO’s announcement also piggybacks on news out of the Federal Reserve earlier in the week that one in four U.S. banks had eased mortgage standards for borrowers with strong credit during the second quarter of 2014, the largest positive swing since 2006.
In late July, Wells Fargo & Co., the nation’s largest mortgage lender, also began lowering the minimum credit scores on its fixed rate jumbo mortgages to 700 from 720, another sign of credit loosening.
Millions of Americans will still find themselves ailing from unpaid or unresolved medical debts, but in the wake of the new FICO score rules and credit belt-loosening by some of the nation’s leading lenders, the pain may have subsided slightly while renewing the hope and possibility of credit access for millions of others.