The most widely used credit score is getting a makeover that could help millions of Americans qualify for better interest rates on mortgages, auto financing and student loans, saving them thousands of dollars.
Starting this fall, a new version of the FICO score will no longer factor in past-due payments that have already been made or give medical debt as much weight in its calculations. Someone who has unpaid medical debts but whose credit history is otherwise good should see their score rise by as much as 25 points, according to Fair Isaac Corp (FICO).
Anyone who has applied for a line of credit or even an apartment knows how important FICO scores have become. The scores, which are based on a 300- to 850-point scale, are calculated using information from reports that are generated by the three major credit bureaus: Experian, Transunion and Equifax. A recent study by research firm CEB Tower Group showed that lenders used FICO scores in making 90 percent of consumer loan decisions.
Changes to the scoring model could make it easier for people to secure affordable loans that they can sustain over a longer period. But a vast majority of lenders would have to adopt the new scoring model for it to have a major impact on consumer credit. In the five years since FICO last introduced a new model, only half of its customers have made the switch.
"It takes a long time for credit scoring systems to achieve critical mass. It takes years for lenders to gravitate from older versions to newer versions," said John Ulzheimer, a credit expert at Credit Sesame, a consumer credit Web site. "The changes will only help consumers inasmuch as the lenders they apply with actually use that new score."
Ulzheimer, a former manager at FICO, pointed out that mortgage financing giants Fannie Mae and Freddie Mac are using an older version of FICO, which has made mortgage lenders slow to adopt new scores. Fannie Mae spokesman Pete Bakel said the company is confident in the tools it uses to set standards for determining which loans are eligible for purchase. Freddie spokesman Thomas Fitzgerald sad the company is evaluating the current FICO version and considering alternatives.
FICO decided to revamp its scoring model after lenders and regulators raised alarms about medical debts in collection dragging down the scores of people who were otherwise responsible borrowers. The company said it studied two years of consumer data and found that unpaid medical debt was not a clear indicator of credit risk.
"People who had a good credit history, where an unpaid medical debt was their only negative, they were still good, reliable customers," said Anthony Sprauve, a spokesman for FICO. "They're not going to default; they're going to pay their bills. The unpaid medical collections is an anomaly."
FICO's findings are in line with a report released in May by the Consumer Financial Protection Bureau. CFPB researchers examined the credit records and payment patterns of 5 million people over a two-year period. They found that people with medical debt generally pay their bills at the same rate as people with higher scores. People who paid off medical debt that wound up in collections were also more likely to repay all other debt, on par with folks whose credit scores were 16 to 22 points higher.
"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,” said Moira Vahey, a spokeswoman for the CFPB.
Medical debt accounts for more than half of all unpaid debts in collection, according to the Federal Reserve. Unlike other types of debt, medical bills are typically the result of unpredictable and pricey events — a heart attack, appendicitis or a severed finger. And there are often lapses between when people are billed and when insurers pay up.
Advocacy groups have argued that neither past-due medical bills or debts in collection that have been paid should hinder credit scores. In response, VantageScore, a smaller rival of FICO, decided last year to exclude paid collection accounts from its scoring model, arguing that it isn't predictive of people's ability to pay their bills.