Innovations and Payment Systems

FICO 9 credit score formula lessens impact of medical debt


People with paid-off debt or medical debts will see scores rise with the new FICO math, while others will receive lower marks

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A new version of FICO’s credit score formula will raise the scores of people with medical debts, or who paid off other debts in collection.

But people with unpaid debts on their record that aren’t related to health care would see their scores fall, making it harder for them to get a personal loan or credit card, or raising the interest rates they’ll have to pay, FICO said.

The changes potentially affect tens of millions of people — but don’t expect big changes in your credit right away. The score is expected to be available to lenders around the end of this year. And lenders typically take months to try out new scoring formulas on their loan portfolios, to see how accurately the new scores predict problem loans.

“They don’t just flip a switch,” said Rod Griffin, director of consumer education at Experian. “They’re going to want to test the new model.”

Bank of America, for example, “will evaluate the benefits of the new FICO model,” BofA spokeswoman Betty Riess said in an email response to questions. “When we look at credit requests, we take into account a number of factors, including our internal customer information.”

FICO’s new formula
FICO, the source of the score used by most lenders, said Thursday that it is rolling out a new formula called FICO Score 9. The new score will drop collection agency accounts that are paid off, whether paid in full or settled, FICO spokesman Anthony Sprauve said. It will also differentiate medical debt from other types of unpaid debt.

Under the new formula, the typical credit score of 711 should rise 25 points for people with medical debts but no other serious demerits on their credit record, Sprauve said. Of all accounts in collections, only about 10 percent are paid off, he said.

Consumer advocates applauded the change — one they have pushed for years — as bringing more fairness to lending decisions. Debt in collection affects a broad swath of U.S. consumers. About 77 million people in the U.S. have some debt in collection on their credit report, according to a study by the Urban Institute and the research arm of debt buyer Encore Capital Group.

“It’s definitely good news — about half of the negatives on consumers’ credit reports are from medical debt,” said Chi Chi Wu, staff attorney at the National Consumer Law Center. Medical debt frequently winds up in collections because of insurance billing problems, not because the consumer can’t pay, she said.

Health care bills are the most common type of debt in collection, representing about 38 percent of total debt collected, according to a survey by the collection industry group ACA International.

Medical debts injure scores
In May the U.S. Consumer Financial Protection Bureau released a study that found people with medical debts were overpenalized on their credit scores, based on their overall debt payment record. For people with paid-off medical debts, the penalty amounted to credit scores 16 points to 22 points lower than people with similar repayment histories, the agency found.

By the same token, people whose unpaid debts were nonmedical benefited from higher scores than their repayment history warranted, the study found. FICO representative Anthony Sprauve said that FICO 9 will result in some reduction of scores for people whose unpaid debts are nonmedical debts, but no estimate of the size of the reduction was available.

It’s definitely good news — about half of the negatives on consumers’ credit reports are from medical debt.

— Chi Chi Wu
National Consumer Law Center

While FICO can make a new formula available, it is up to lenders to use it to evaluate loan applicants. The FICO 8 formula was announced in 2009, and in 2010 FICO said that 2,700 lenders were using the new formula. But it wasn’t until mid-2011 that it announced a major credit card issuer — Citi — had adopted the new formula, saying the card business had evaluated the new formula for 18 months. Griffin of Experian said some lenders continue to use early scoring models back to FICO 2 and 3.

“We hope the fact that the CFPB did their own research very rigorously will help convince lenders to adopt this,” Wu said. However, she noted that Fannie Mae and Freddie Mac, the major players in the mortgage market, use an older FICO scoring formula, so many mortgage applicants might not see a change in how their credit measures up.

FICO scores — which range from 350 to 850 — are calculated using the payment information on credit reports kept by the three major credit bureaus, Equifax, Experian and TransUnion. Different versions of the formula are available for car loans, credit cards and other types of consumer loans. More than 200 different scores are available from analytics companies that use Experian data, Griffin said. FICO, formerly Fair Isaac Co., says its scores are used in 90 percent of lending decisions.

VantageScore, a competitor formed by the major credit bureaus, said its current 3.0 model excludes paid collections. However, unpaid medical debt does weigh against a consumer’s score.

As consumer behavior changes, credit scores have to adapt, Griffin said. Since the recession of 2009, credit card balances have fallen substantially and delinquencies on consumer loans have plunged, marking changes in consumers’ risk levels. “What may have been an indicator of risk isn’t any longer, or isn’t as strong,” he said, “because people’s behavior has changed.”

See earlier coverage: Long-awaited credit scoring revisions unveiled, Congress considers relief for credit damage from medical bills

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