Two months ago, I sat across a table from a woman on the verge of tears. As she clenched her jaw and cast her eyes towards the ground, she disclosed her overwhelming financial situation. An unexpected medical expense depleted her savings and sent her into a downward spiral of financial problems complete with collections agencies pestering her for payment. Even though she paid her other bills on time, avoided consumer debt and worked two jobs to support her family while trying to pay off her medical bills, she felt bankruptcy was the only way out.
Unfortunately, her story is familiar to many other hard-working, responsible Americans around the country. An unexpected medical expense can quickly send the most diligent and responsible people into dire financial straits. Those unpaid debts go to collections, causing a major hit on a credit report and score. Once a person’s score drastically drops, it becomes hard to get a loan to refinance debt without a staggeringly high interest rate.
As of July, about 64.3 million consumers in the U.S. had a medical collection on their credit report, according to data from credit bureau Experian (EXPN), and a hope is on the horizon for them.
FICO (FICO) –- the company behind credit scores -– on Thursday announced an unprecedented change to its scoring model: FICO Score 9 will change the way in which paid collection agency accounts, unpaid medical bills and non-medical bills impact a score.
What Are the Changes?
Under the current model, a collection generally stays on a credit report for seven years -– even if it is paid off. This is the same amount of time bankruptcies and foreclosures stay on a report. Now, consumers will see their paid collections being removed from their credit reports.
According to The Wall Street Journal, of the 106.5 million consumers with a collection on their report, 9.4 million had no balance. Those 9.4 million American won’t be penalized under the new credit-score system.
Unpaid medical bills will now carry lower weight compared to non-medical debt going to collections.
“The median FICO score for consumers whose only major derogatory references are unpaid medical debts is expected to increase by 25 points,” according to FICO’s release on the new model.
FICO also said it will refine the way in which consumers with “thin files” or minimal credit history are judged. Instead of solely focusing on paid or unpaid bills, the company wrote in the release, it has quantified the various degrees of a consumer’s payment history.
Why Does This Matter?
In May, the Consumer Finance Production Bureau released a report questioning the legitimacy of using medical collections as proof of a consumers’ trustworthiness.
In one example, the bureau pointed to consumers who are unaware of unpaid medical collections because they believed insurance had covered a co-pay or bill. If a consumer doesn’t know a collection action has even been taken, he shouldn’t be penalized on his credit score, especially if the small collection is immediately paid off.
According to its analysis, the CFPB determined consumers with more paid than unpaid medical collections had delinquency rates comparable to consumers with credit scores approximately 20 points higher. It appears FICO took heed of the CFPB’s analysis and decided to stop penalizing consumers with unpaid medical bills in the same manner it treats non-medical bills in collections.
But Seriously, Why Does This Matter?
It matters because a higher credit score can help a consumer become competitive for loans with lower interest rates -– or competitive for any loan at all (from a credible lender).
This will likely mean millions of Americans struggling to pay down medical debts are going to be eligible to refinance their debt at lower rates and get a better handle on their financial situation.
Perhaps this will also reduce the number of responsible, hard-working Americans who feel their only options to get out from under their medical bills are bankruptcy or seeking money from predatory lenders in the form of payday loans or title loans.
When Will You See the Changes?
It’ll take 12 to 18 months to see the changes, according to Nick Clements, co-founder of MagnifyMoney.com and a former bank executive with experience implementing new scoring models.
In a post for the site, Clements said a bank first works to understand the impact a new score will have on its existing portfolio, which often will take at least six months. Next, the bank will set up new pricing strategies and prepare its systems for the new scoring model by implementing new rules and analytics. This process often takes six months to a year.
Customers shouldn’t expect a call telling them their loans’ interest rates have been reduced.
Once FICO 9 is in place, existing bank customers shouldn’t expecting a call telling them their loans’ interest rates have been reduced. The bank is far more likely to use reduced rates to lure in new customers than to please existing ones. Instead, consumers should take the initiative to shop around their debt and check the rates with other banks, credit unions or personal loan lenders.
Ultimately, FICO’s new scoring model should provide a much-needed boost to millions of Americans who fell on hard times and are otherwise fiscally responsible and should be eligible for competitive interest rates on their loans, mortgages and other financial products.
Erin Lowry writes for DailyFinance on issues relating to millennials, money and personal finance. She is the blogger behind Broke Millennial, where her sarcastic sense of humor entertains and educates her peers. She is also the brand and content manager for MagnifyMoney.