New Treatment Of Medical Debt Could Raise Consumers’ FICO Scores

Certain consumers hoping to secure a mortgage for a home purchase may have just gotten a big break, as FICO is adjusting its credit score system by separating medical debt from all other debt and by lowering the impact that medical debt has on a consumer's overall credit score.

The analytics software company's new FICO Score 9, with its new and separate treatment of medical debt, could add as many as 25 points onto a consumer's credit score, provided the only thing dragging down that consumer's score is medical debt, the company reports.

That, in turn, will likely make more consumers eligible for mortgages. For example, many lenders dealing in conventional 30-year mortgages now require an average minimum credit score of around 740, for approval. A consumer with medical debt in collections, but no other debt in collections, will have an average credit score of around 711, according to FICO. Thus, the new treatment would result in such a consumer gaining 25 points – possibly making him eligible for a wider array of loans.

The new scoring system also ignores any collections that have already been paid. Previously, the scores factored paid and unpaid collections equally, though they ignored amounts under $100.

In addition, the company claims the new modeling techniques used in FICO Score 9 are more predictive of a consumer's likelihood to repay a debt, compared to previous versions.

What's more, FICO Score 9 will help lenders better assess the risk of consumers with limited credit history – the so-called ‘thin files.’

The new scoring system will go into effect with the U.S. credit reporting agencies this fall.

‘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,’ says Jim Wehmann, executive vice president for Scores at FICO, in a statement. ‘By applying innovative, predictive modeling techniques on recent data to capture consumer credit behavior, FICO Score 9 will extend FICO's leadership in providing the credit score that most accurately and fairly defines U.S. consumer credit risk.’

Steve Brown, president of the National Association of Realtors, says, ‘This move will ultimately make a real difference in the lives of millions of Americans, who have been shut out of the housing market or forced to pay higher mortgage interest rates because of flawed credit scores. Since the housing crash, overly restrictive lending has been the greatest obstacle to homeownership.’

The changes in FICO come mainly as a result of pressure from regulators and various industry groups that see medical debt as being one of the primary culprits holding back the economic recovery – and, in particular, the housing recovery.

In May, the Consumer Financial Protection Bureau (CFPB) released a report showing that some consumers are being overly penalized on their credit reports for medical debt in collections.

Part of the problem, the CFPB says, is that the consumer credit reporting agencies treat medical debt the same as any other debt. But, as the CFPB points out, it's not the same as going to collections for things such as utility bills, because, very often, medical debt arises from unforeseen events such as injuries and illnesses.

Sometimes the debt arises from billing issues with medical providers or insurers. The CFPB says some of the complaints it has received indicate that many consumers do not even know they have a medical debt in collections until they get a call from the collections agency or they discover the debt on their credit report.

Meanwhile, a recent study by the Federal Reserve Board shows that more than half of all collections on credit reports are associated with medical bills.

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