Yesterday, FICO announced that it will be releasing FICO Score 9. If you have unpaid medical bills or other collection items, this change will impact you.
What is FICO?
FICO is the most widely used credit score in the country. 90 percent of all credit decisions (mortgages, cards, credit cards, personal loans and more) use the FICO score in some way.
So, when FICO makes a change to its score, we should listen. This score has a big impact, because lenders use it and others (like CreditKarma) are trying to approximate it.
What are they changing?
This change is huge for people with unpaid medical bills and other collection items.
Unpaid medical bills
According to Experian, 64.3 million Americans have a medical collection record on their bureau. In the current world, this can significantly harm their credit score.
If you have an unpaid medical bill, it can be reported to a credit bureau in two ways:
- The medical service provider can report to the bureau, or
- A third party debt collection agency that has purchased the debt, or has been contracted to collect the debt, can report it
99.4 percent of cases have been reported by collection agencies. So, if your doctor is calling you to pay – it probably hasn’t been reported to an agency. But, once a collection agency starts calling you, you probably have a negative item on your credit bureau.
The purpose of a credit score is to help lenders understand the likelihood of someone being responsible and paying back on time. There has been a widespread belief that people have been unfairly punished for medical bills. In fact, the CFPB has proven that people have been unfairly punished, in a May 2014 report.
With the new score, FICO is agreeing with the CFPB. Medical collections will now be differentiated from non-medical collections. And people will be “punished less” for medical collections. This makes sense, for three reasons:
- The medical system is complex, and many people have been hit with small medical collections that they didn’t even realize they owed. For example, with a small co-pay that ended up with a collection agency.
- Historically, many responsible people could not get insurance because they had a pre-existing condition. And, when medical disaster struck, they had no way to pay the medical bills. They tried to be responsible, but couldn’t.
- Even with insurance, multiple emergencies in a family can lead to large deductible payments. Doctors and hospitals can quickly turn over bills to collection agencies, resulting in a negative remark on the credit bureau. Even people who are just paying back their medical bills, responsibly, over time can be punished.
This is a big win for the CFPB. Hats off. A government agency has done the math for the industry, and the industry has agreed. This should result in better access to credit, and lower rates on existing credit – once (and if) the changes are accepted by the industry.
Paid Collection Accounts will now be bypassed
Beyond medical bills, many other types of debt can end up on your credit bureau. For example, failure to pay your utility bill, your phone bill, your overdraft or any other type of debt can result in your account being sold to a collection agency. And the agency will usually report the collection account on your bureau. Having these accounts can seriously harm your score.
But, the older the collection item, the less impact it has on your score. I have regularly met people who felt confused. They have recovered and now had money. Should they pay back that five-year-old collection item, or just let it age. They wanted to pay it back, but would receive advice from some people not to do so. Why? Because activity on a collection item could make it appear more recent.
This change removes all ambiguity. If you pay back your collection items, your score will benefit. This is the way it should be.
When will I see the impact
Unfortunately it will take a while. FICO sells its credit score to banks. Whenever a new score is introduced, a bank has to decide whether or not to upgrade. In order to make this decision, they need to do a lot of analysis.
First, they will perform a “retro” analysis. This means they will look at the past few years of their portfolio history, and they will estimate how the portfolio would have performed if the new score was used.
They will then need to build strategies, which includes the cutoff (above what score will they approve accounts), the pricing and the extra rules that they want to build. In my experience, this takes 12 to 18 months (there are so many committees that need to approve this!).
Banks are very eager to “swap in” new customers. So, if previously rejected customers can now be approved, banks will be keen to proceed.
They are less keen to charge people lower interest rates. So, the CFPB needs to watch the banks closely. If people are truly lower risk, they should pay lower prices. But, banks are not eager to reduce pricing.
We fully support the changes. Medical bills are being severely punished. And people should not be afraid to pay off collection accounts.
We are realistic: it will be a while before we feel the impact.
And we are rightly skeptical: banks will be happy to approve more people and give more credit. They will be less excited to reduce interest rates.