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FICO to discount medical debt from credit scores

New rules will improve credit scores, help lenders better assess risk

A move by personal credit score provider FICO to leave out or discount medical debt from its scores will boost the credit ratings of many borrowers, while helping lenders to better assess risk.

Moreover, FICO won’t consider past overdue bills borrowers have already paid, the Wall Street Journal reported Friday. The new score will be available to lenders through U.S. credit reporting agencies starting this fall, FICO said.

Lenders have become extremely wary of any blemishes on borrowers’ credit scores, following the economy-crippling sub-prime mortgage crisis of the late 2000s, where banks wrote predatory adjustable rate mortgages for years to people who were not creditworthy. As the house of cards collapsed, their interest rates shot up to levels they couldn’t pay.

With FICO’s new rules, negotiated between lending groups and the U.S. Consumer Financial Protection Bureau (CFPB), that era of tight lending practices could be coming to an end — increasing the chances that borrowers will get their loan applications approved or pay lower interest rates.

The FICO change comes after the CFPB said in a report this year that credit scores overly penalize people with medical debt compared to other types of debt.

"Given the critical role that credit scores play in consumers' lives, we welcome steps by industry to adjust how it weighs medical debt in order to be as precise as possible in predicting the creditworthiness of a consumer," a CFPB spokesman said on Friday.

In the previous arrangement, after a debt collector calls, a consumer might pay the debt immediately but still take a hit to his or her credit score, according to the CFPB.

The new scoring system will do a better job of identifying risky borrowers and help sub-prime lenders mitigate the risk of doing business with such borrowers, said John Ulzheimer, a credit expert and a former FICO employee.

"I am not exactly sure what impact this is going to have on sub-prime lenders, because for the score to be meaningful to the customers, the lenders have to actually start using that score," Ulzheimer said.

When calculating credit risk, the credit scoring company, formerly known as Fair Isaac Corp, said on Thursday that it would ignore overdue medical payments and other bills that have already been resolved.

Medical debt represents about half of the debts that go to collections in the United States, according to the Federal Reserve.

More than a third of Americans have had a collections agency after them, according to a recent Urban Institute study. According to the Wall Street Journal, the number is about 64 million, citing Experian, another credit-rating group. 

The new model will also discount overdue medical payments yet to be made under the new scoring model, helping improve the median FICO score by 25 points for consumers who mainly have unpaid medical debts, the company said in a statement.

Consumers end up with medical debt for different reasons than they incur other debt, such as home loans or credit card debt. For starters, it’s involuntary. Incurring debt due to severe, expensive illness or injury isn’t the same as buying an unaffordable sports car. 

With medical debt, sometimes borrowers don’t realize their insurance companies haven’t paid the entirety of their bill, and their arrears get kicked over to collections agencies that won’t take no for an answer.

The FICO score changes will address that by weighing medical debt less heavily than unpaid credit card debt and other collection information, according to the statement.

Al Jazeera and Reuters

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