Many consumers who have been denied credit or charged higher interest rates due to a low credit rating could soon be in a better position as the nation’s most widely used credit scoring agency is revamping how it computes credit scores.
Fair Issac Corp., creators of the FICO score, announced its calculations will no longer include any record of a consumer failing to pay a bill if the bill has been paid or settled with a collection agency. The new FICO score also will give less weight to unpaid medical bills that have gone to collection agencies.
FICO Score 9, as it’s been named, will be released to the three major credit bureaus this month. After testing and validating the new score, the credit bureaus will make it available to lenders later this year. Lenders must decide when they will begin using it.
The changes are expected to increase the number of people approved for loans, especially those shut out of the credit market due to medical debt sent to collection agencies. FICO representatives said consumers whose only major flaw on their credit reports is medical debt collections will see their scores increase by a median 25 points.
More than 64 million consumers in the U.S. have medical debt collections on their reports, according to credit reporting agency Experian. The Federal Reserve Board reports over half of all collections listed on credit reports are associated with medical bills.
“In developing FICO Score 9, we were able for the first time to look at medical debt collections data separately from all debt collections,” said Anthony Sprauve, senior consumer credit specialist for San Jose, Calif.-based Fair Issac Corp. “Previously, all collections data were lumped together, preventing the FICO score algorithm from looking at different types of collections individually.
”Now that we can do that, we have found that consumers with a medical debt collections being the only negative item in their credit history are not a greater credit risk.“
Medical debt is treated differently because consumers often do not know they have a medical debt that has gone into collections until after it has been reported to a credit bureau. Also, medical costs are often due to unexpected illnesses and accidents, so medical collections are not considered as negative for a person’s payment history as a regular unpaid debt.
Debt collections stay on a person’s credit report for as long as seven years even if the debt has been paid off. The new FICO score, however, will not penalize the consumer for having a debt in collections as long as it’s been paid or settled.
FICO unveiled its new scoring techniques on the heels of a scathing report earlier this year from the Washington, D.C.-based Consumer Financial Protection Bureau, which found consumers’ credit scores were overly penalized for medical debt in collections. The bureau also charged that credit scoring models were underestimating the creditworthiness of consumers with such debt.
The three-digit credit scores compiled by credit bureaus play a significant role in everyday life because most lenders use the scores to decide whether or not to grant credit and at what interest rate. When overdue debt goes to a collection agency and ends up on a credit report, it reduces a person’s score and makes lenders more cautious about granting credit because the borrower is perceived to be more risky.
While FICO scores range from 300 to 850, most credit scores fall between 600 and 750, according to Experian. A score above 700 usually suggest good credit management.
The average balance for households that have credit card debt is $15,480, according to NerdWallet.com,
With about 90 percent of lenders using FICO scores to make credit decisions, Fair Issac is the leading credit scoring agency in the U.S. But the company has competitors that have led the way in adapting scoring methodologies that determine credit risk.
VantageScore Solutions, a Stamford, Conn.-based rival, introduced a new scoring model in March 2013 that excluded all paid collections.
Tim Grant: email@example.com or 412-263-1591.