From mortgages and car loans to apartments and job applications, the ubiquitous and somewhat mysterious credit score is a singularly important factor in business decision making. Now, thanks to a recently announced change to their methodology, the company that maintains the infamous FICO score will diminish the importance of some negative items on the number. The change means that millions of consumers may see a measurable improvement in their credit profile.
Fair Isaac Corporation (FICO), creator of the eponymous formula for estimating creditworthiness, announced that it would modify the weighting of certain types of negative information in a borrower's credit history. Beginning sometime this fall, accounts that were turned over to collection agencies but subsequently settled in full will no longer be counted in the computation. Collection actions are presently included for up to 7 years.
Additionally, the company will now view medical debt differently from traditional credit accounts like car loans and credit cards, and will place less emphasis on hospital and doctor bills sent to collection. That should mean many more potential borrowers will be able to qualify for a mortgage or to refinance an old high interest loan.
The concept of a credit score began in 1956 when Bill Fair and Earl Isaac set out to apply modern data analysis techniques to improve business decision making. Today the FICO score is used in 90 percent of consumer lending decisions, as well as in evaluating job applicants and potential tenants. FICO scores utilize information from credit reporting bureaus including payment history, debt levels, length of credit history and types of debt outstanding as well as other information. Scores range from 350 to 850, with an average score in the range of 680-720 and an excellent score above 750.
The Consumer Financial Protection Bureau released a study in May that suggested medical debt collection actions often resulted from lack of awareness or conflict over insurance reimbursements, and that these actions were significantly less predictive of future delinquencies than other types of debt default. According to credit reporting company Experian, over 64 million Americans had medical obligation collection activity on their credit records. To their credit (excuse the pun), FICO responded to these findings by modifying their scoring model to place less weight on these types of negative records.
The changes announced by Fair Isaac could potentially add up to 25 points to a borrower's score if the only detrimental info is medical debt or settled collection action. At the margin, the improvement could qualify the consumer for a lower rate loan and save many thousands in interest expense over the life of a typical mortgage.
Your credit score still depends mainly upon your previous record with lenders, and the best tool for building a robust score is timely repayment. But for good borrowers that have had a bad experience with health care bills, some relief may be in store.
A good step to take is to review your credit reports at the 3 major reporting agencies. You can procure one per year at no cost by visiting www.annualcreditreport.com. Then review the information for accuracy and type. The website describes how to correct inaccurate information.
Christopher A. Hopkins, CFA, is a vice president for Barnett & Co. Investment Advisors.