August 12, 2014 by Lisa Brammer
If you follow this blog, or one like it, you know we talk a lot about the importance of a good credit score. Credit scores not only help creditors decide whether or not consumers can borrow money, they also determine how much loans will cost. It’s no secret, consumers with the highest credit scores are given the best interest rates.
The Fair Isaac Corp., better known as FICO, is virtually synonymous with credit scoring and is one of the best known names in the credit industry. Last week, they announced that they have a new formula, FICO Score 9, for calculating credit scores.
This new model will no longer weigh medical debt as heavily as it had in the past and debts that were in collections, but are now paid-off will no longer have a negative impact on a person’s score.
In a written statement, FICO promised its new rating formula would provide a more nuanced way to assess consumer collection information. “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, executive vice president for Scores at FICO.
Back in May of this year, the Consumer Financial Protection Bureau (CFPB) released a research report that stated that medical debt that ends up in collections and then on a consumer’s credit report may overly penalize consumers’ credit scores. According to the report, the current credit scoring models were underestimating the creditworthiness of consumers who had medical debt in collections. “Getting sick or injured can put all sorts of burdens on a family, including unexpected medical costs. Those costs should not be compounded by overly penalizing a consumer’s credit score,” said CFPB Director Richard Cordray. “Given the role that credit scores play in consumers’ lives, it’s important that they predict the creditworthiness of a consumer as precisely as possible.”
Starting this fall, when the new scoring will be available to lenders, millions and millions of consumers can expect their credit scores to suddenly go up—even with no change in their financial circumstances. Because of the new scoring formula, consumers with an average score of 711, and an otherwise clean credit history—except for unpaid medical debts—may see an increase of 25 points in their FICO scores.
While it’s true that a lot of medical debt is unexpected and happens through no-fault of the consumer, medical debt is one of the leading causes of bankruptcy in the United States. And that fact shouldn’t escape lenders. Being in collections will still show up on a consumer’s credit report and cautious lenders can still take that into consideration.
Some critics think that relaxing the standards might bring losses for borrowers as well as lenders. “A lot of people really just can’t handle credit—you’re not really helping them by allowing them to dig themselves into debt,” said Howard Strong, a lawyer in Tarzana, California, who specializes in consumer-protection class-action lawsuits. “It’s like a sharp knife—if you don’t know how to use it, you can cut yourself.”
“FICO’s new scoring logic will help some consumers more than others,” said John Ulzheimer, president of Consumer Education at CreditSesame.com. “Consumers who have pristine credit reports but for medical collections will also likely see their scores skyrocket when those collections are paid, settled and then eventually updated to show a zero balance, as they’ll be ignored.”
Founded in 1950, United Credit Service, Inc. is a full service, licensed revenue cycle management and debt collection agency in Wisconsin providing highly effective, customized one on one management and recovery solutions for our business partners. We offer pre-service collection solutions as well as traditional back-end collections. Visit our website at http://www.unitedcreditservice.com or call 877-723-2902.