If you have medical debt, you probably could stand some good news. So here goes: You could soon see a bump in your credit score by about 25 points.
That may be enough to qualify you for lower interest rates on consumer loans.
This potential increase is possible because Fair Isaac Co. — at the urging of the Consumer Financial Protection Bureau — is revamping the methodology it uses to create its industry-dominant FICO credit scores.
For one thing, it will no longer count medical debts as heavily as it previously did.
In addition, these newer FICO scores, which the company expects to be available this fall, will also ignore any collections that have already been paid. Previously, the scores treated paid and unpaid collections equally.
Collections can stay on credit reports for as long as seven years, even if you paid off that debt and remained up-to-date on your other loans.
According to the Federal Reserve, more than half of all collections on credit reports are associated with medical bills. But a recent CFPB study found consumers were being overly penalized for medical debt that goes into collection and shows up on their credit reports.
The CFPB maintains that medical debts differ from other unpaid debts — like a late utility bill or car loan — in that they can be unpredictable and unexpectedly costly. Yet current scoring models don’t differentiate.
The agency says many consumers do not even know they have a medical debt in collection until they get a call from the collection agency or they discover the debt on their credit report.
Current credit scores may underestimate creditworthiness by 10 points for consumers who owe medical debt, according to the consumer watchdog, and by up to 22 points even after paying it off.
Apparently FICO has listened.
The company, in announcing its new credit scoring model, says that the median credit score for consumers whose only major negatives are unpaid medical debts is expected to increase by 25 points under the new model.
FICO scores range from 300 to 850.
Save on interest payments
While a 25-point increase doesn’t sound like a lot, it could mean substantial savings in lower interest rates and monthly payments.
According to a loan savings calculator on myFICO.com, someone with a score of 720 could expect to pay $443 a month on a $20,000, four-year auto loan, based on an APR of about 3%. Knock that credit score down just 25 points, and the monthly payment increases by $15.
Over the four-year life of the loan, the person with the lower score would pay about $550 more in interest.
Bigger loans equal more savings.
For a $200,000, 30-year fixed-rate mortgage, a borrower with a 760 score would pay $930 a month, based on a 3.78% APR. A borrower with a score of 735 would be eligible for a 4% loan and pay $956 a month or $9,000 more over the life of the loan.
FICO says that 90% of all consumer lending decisions in the U.S. are based on its scores. Twenty-five of the largest credit card issuers and 25 of the largest auto lenders use the scores to make credit decisions.
There is one caveat, though. Just because FICO changes its scoring model doesn’t mean lenders have to adopt it.
The New York Times reported that FICO last introduced a new model five years ago. Since then, about half of its customers have adopted that model.