The vast majority of lenders – an estimated 90% – use FICO credit scores to help them assess loan and credit applicants. A poor FICO score often means difficulty in getting loans and credit cards, and higher interest rates and more restrictions when credit is granted.
If your poor FICO score is caused primarily by medical debt, you may be in luck. The all-important formula used to calculate FICO scores is changing – to the benefit of some, such as those with medical debt, and to the detriment of others.
In an August 7th news release, FICO introduced FICO Score 9, a new method of evaluating creditworthiness. The new method brings three major changes:
- Debt in Collections – Debts that go to collection agencies but are repaid will not linger and count against your FICO score. Previously, credit models have not made a distinction between paid and unpaid debt sent to collections.
- Effect of Different Types of Debt – Medical debts will not have such a pronounced impact on the score – those who are held back only by medical debt should expect around a 25-point increase in their score. Others whose debt is not related to medical issues may see their scores decrease.
This stems from a study released in May by the Consumer Financial Protection Bureau (CFPB) that concluded that paid-off medical debt distorted the overall debt picture. When those with paid-off medical debt were compared to those with similar repayment histories but no medical debt, those with medical debt were penalized around 16-22 points.
Medical bills account for over half of the overdue debt turned over to collections, in part because of unpredictable billing totals and the effects of insurance payment uncertainty and timing. In essence, medical debt tends to drag down even the most responsible borrowers. The CFPB received many complaints from those who did not realize they had an overdue medical bill until they were contacted by a debt collector or found it while checking a credit report.
A side effect is that those who incur other types of debt in collections such as rent, utility bills, and telecommunication bills are going to see a downward shift in their scores. FICO chose not to predict a typical drop.
- Assessing Limited Histories – FICO has changed the method of assessing the credit of those with limited histories, such as recent college graduates that are just starting their careers. FICO’s news release notes that the new process looks at repayments in degrees of risk.
If you expect your credit score to improve due to this scoring method, you should be pleased – but temper your enthusiasm. The new system won’t kick in until the end of the year, and lenders will likely going to run an evaluation period of some months to see how well the new algorithms predict loans with repayment issues.
There is also no guarantee that a lender will upgrade their FICO system version. Some lenders use versions older than the current FICO Score 8, and if they do not see a difference in accurate prediction of bad loans, they are not likely to bother with an upgrade this time, either.
In short, it could be a year or longer before your credit score is affected and considerably longer for the new scoring to be fully accepted by all lenders. That makes it even more important to shop around with different lenders for your loans and credit cards. It is also important to keep your non-medical bills from ending up in collections, and to pay them off in full should they end up there.