Tuesday, January 23, 2018
Business

Change in formula could lead to higher credit scores

The creator of one of the most widely used and influential credit scores, FICO, said last week that the latest version of its score would no longer weigh medical debts — which account for about half of all unpaid collections on consumers' credit reports — as heavily as it did in previous iterations.

The newer FICO scores, available this fall, will also ignore any overdue payments that have already been made; previously, the scores factored paid and unpaid collections equally.

FICO credit scores, which have become consumers' financial passport to just about everything from rental apartments to most loans, are based on the information in an individual's credit reports that are generated by the three major credit bureaus: Equifax, Experian and TransUnion. The scores are based on a 300- to 850-point scale.

Because of the new scoring model, individuals with a median score of 711 — and an otherwise clean credit history, except for unpaid medical debts — may see their FICO score rise by 25 points. As a result, many consumers may qualify for more attractive interest rates on various loans, potentially resulting in thousands of dollars in savings.

"It probably doesn't mean the difference between an approval and a denial, but it can mean the difference in a more advantageous rate," said John Ulzheimer, a credit expert at Credit Sesame, a consumer credit website, and a former FICO employee.

But consumers whose credit files are tarnished only by unpaid medical debts that went to collection agencies — but were ultimately settled or paid — are likely to see a much greater increase in their scores. "That is when you could expect to see your score go through the roof," said Ulzheimer.

The new scoring approach came after FICO spoke with some of its largest customers, including major lending institutions, as well as regulators, who suggested that medical debt collections were unduly weighing on consumers' scores. FICO said it then analyzed new data from the credit bureaus, and compared how consumer behavior varied depending on the type of collection debts on their credit reports.

"We found that for someone where medical collections is their only derogatory, it is not as negative as a regular unpaid collection would be," said Anthony Sprauve, a FICO spokesman. "So we adjusted the algorithm."

Many consumers, often unwittingly, have paid higher interest rates because unpaid medical debts have dragged down their scores. In some cases, medical bills ended up in the hands of collectors because of a billing error or some other confusion about what should have been paid by health insurance.

And in May, the Consumer Financial Protection Bureau released the results of its own study, based on 5 million anonymous credit records, which found that consumers may be overly penalized for medical debts that go to collections.

FICO is not the first to tweak its approach on paid collections. Last year, VantageScore — a joint venture of the three major credit-reporting companies that generates its own credit score — said it would ignore collection actions on credit reports, as long as they were paid. VantageScore has not said whether it would weigh unpaid medical collections differently from nonmedical collections.

For consumers to see any benefit, however, lenders have to adopt the new scoring techniques. FICO last introduced a model, called FICO 8, in 2008. Since then, FICO said that about half of its customers had started using that model.

Mortgage lenders have been slower to adopt new scores, and most are using even older versions, experts said, because Fannie Mae and Freddie Mac are still using them in their own underwriting software. Fannie and Freddie did not say whether they had plans to switch to the updated FICO score that weighs medical collections less heavily. But they both said they were confident in the tools they use.

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