Fair Isaac Corporation, the company that produces the FICO score, announced its FICO 9 model, which ignores bills in collection that have already been paid and puts less weight on medical bills in collection.
If the rest of your credit is clean, aside from a medical bill in collection, FICO says your score could rise as high as 25 points thanks to FICO 9.
"FICO Score 9 uses a more refined treatment of consumers with a limited credit history and those with accounts at collection agencies, so that lenders can grow their credit and loan portfolios more confidently," said Jim Wehmann, executive vice president for Scores at FICO.
Plenty of consumers find themselves dealing with collection agencies. Under FICO 9, any bill that was in collection, but has now been paid or settled, will no longer hurt your score.
Previously, once the collection appears on your credit report, it stays there for up to 7.5 years, even if you've paid off the bill or settled the claim and continues to hurt your FICO score.
"Even after you pay off a bill that has been in collection, the status will be switched to 'paid' on your credit report, but that doesn't do much for your score," says Gerri Detweiler, director of consumer education at Credit.com.
Also under FICO 9, collections related to medical bills, even if they have a balance, will be discounted from the score, but not completely ignored. This is beneficial because some medical bills could be a small $25 doctor's copay that eventually heads into collection, wreaking havoc on your credit for years to come.
Medical bills can be inherently tricky. In fact, the Consumer Financial Protection Bureau released a report in May citing the issues surrounding medical bills and credit. It said some consumers may not even know they owe such bills and also questioned whether medical bills reveal much insight on how risky a consumer is from the lender's perspective.
After all, the goal of a credit score is to determine a customer's credit worthiness. Lenders don't want to lend to consumers who have managed money poorly in the past, for fear of not being paid back in the future. Should a consumer have a low credit score, the financial institution may not lend to him or it may charge a higher interest rate as compensation for the extra risk in taking the person on as a customer.
While the changes in FICO 9 could cause scores to rise, it's unclear when lenders will latch on to the new model.
"This doesn't happen overnight," says John Ulzheimer, president of consumer education at CreditSesame. "FICO 8, the previous model, has been out since 2009 and it has finally achieved critical mass five years later, so consumers may not realize the helpful aspects of the latest scoring model for quite some time."
Both Detweiler and Ulzheimer agree the mortgage industry will be the slowest to adopt the new model. Government-sponsored enterprises Fannie Mae and Freddie Mac, which buy mortgages from other banks and securitize them to sell to other investors, must approve the scoring model for mortgages it deals with and they aren't even using FICO 8 yet. Fannie and Freddie are major players in the mortgage market and guarantee the majority of mortgages.
"They'll be two generations behind once FICO 9 takes effect," Ulzheimer adds.
- Written by Scott Gamm for MainStreet. Gamm is author of MORE MONEY, PLEASE.