FICO Credit Scores Will Be More Forgiving of Medical Debt

NEW YORK (TheStreet) — Tough lending standards introduced after the financial crisis have barred millions with tarnished credit from buying a home, trading up or refinancing. But a few would-be borrowers may soon find the door opening a crack — assuming their financial problems relate to medical bills.

FICO, the credit rating firm, says procedures to be in place by year end will be a bit more forgiving of people who have been targets of debt collectors, so long as the trouble concerned medical bills. In other words, your credit score will be hurt less by a bad debt to a hospital than one to a car dealer or credit card company.

Credit scores are based on factors such as a person's debts, credit lines and payment history to gauge the odds the person will default in the future. FICO's move, part of a new credit rating process called FICO Score 9, recognizes that a bad debt due to a medical issue, which typically comes from bad luck rather than bad judgment, does not necessarily mean the individual is a poor risk. The approach should be especially beneficial to borrowers with thin credit histories, FICO said.

"For example, instead of classifying a consumer as someone who paid or didn't pay her bills in absolute terms, the various degrees of the consumer's payment history have been quantified," FICO said in a press release. "The end result is a score with an improved ability to assess the risk of thin files."

FICO says the process harnesses the powers of predictive analytics, which examines very large databases for insights too subtle to be found in small samples. 

The average person with a history of collection actions for medical bills should see his or her credit score rise by 25 points, the firm says. That doesn't sound like much, but in marginal cases it could make the difference between being denied a loan and getting one.

And it could help a borrower get a lower loan rate, says Keith Gumbinger, vice president of HSH.com, a mortgage and housing information company. In his example, a borrower with a FICO score of 660 to 679 who put 10% down would likely be offered a mortgage charging 4.625%. If the new approach to medical debt lifted the applicant's score to 680 to 699, it might be possible to get a loan rate of 4.375%.

Fore every $100,000 borrowed, that would drop the monthly payment to $499 from $514. On a $300,000 loan, the homeowner would save $5,400 over 10 years.

It's not clear how many loan applicants might benefit from the new approach to medical debt.

Also, it's too soon to know how many lenders will adopt the Score 9 approach. Lenders buy a package of services from credit rating agencies such as FICO, and many do not upgrade immediately when a new version is offered. Still, lenders make money by approving loans, not denying them. A system that says certain applicants are actually not as risky as assumed could appeal to many mortgage firms.

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