Credit Score Change Could Set Up Consumers to Fail
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Credit Score Change Could Set Up Consumers to Fail


The U.S. economy is only just now beginning to look as though it is really recovering from the financial crisis and the Great Recession, but an announcement by the credit rating firm FICO last week suggests that some of the lessons of the crisis might not have truly sunk in.

In short, with no change in their financial circumstances, many millions of consumers can expect their credit scores to suddenly go up around the end of the year. FICO reported last week that it will change the way it treats medical debt and debts that were sent to collection and subsequently paid off.

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Those who remember the mortgage crisis, which helped launched the aforementioned financial crisis, will recall that much of the problem was that lenders were offering credit to individuals who probably shouldn’t have been getting loans. These bad loans were then bundled together and sold to investors, many of whom were unpleasantly surprised at the number of them that went into default.

Now, FICO is changing one of the main tools lenders use to assess creditworthiness, by ignoring or discounting certain kinds of credit problems.

Debts related to medical procedures will receive significantly less weight in the updated rankings, and debts that went to collection but were paid off will have no negative effect on an individual’s credit score.

FICO, in a press release issued Thursday, promised that its new ratings would provide “a more nuanced way to assess consumer collection information” and would “help lenders because they result in greater precision.”

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The change in the treatment of medical bills is fairly easy to understand. As the Consumer Financial Protection Bureau has pointed out, medical bills can be extraordinarily expensive and are often quite unpredictable. And often, unpaid medical bill simply reflects a fight between an insurance company and a health care provider, and has little to do with the consumer’s creditworthiness.

However, it’s hard to understand what banker, when considering an application for a mortgage or even an auto loan, wouldn’t consider a debt sent to a collection agency to be a relevant data point. And whether it’s justified or not, medical debt is among the leading causes of bankruptcy in the U.S. 

In the end, the worst-case scenario is that the new scores will result in many consumers getting loans they shouldn’t, landing in serious financial trouble. The best-case scenario is that FICO has actually come up with a method that really is better at predicting creditworthiness. In the end, it’s bankers and other lenders who will be on the front lines in assessing the changes.

Nessa Feddis, senior vice president for consumer protection and payments at the American Bankers Association, pointed out that FICO is in the business of selling ratings that reliably predict borrowers’ default rates. 

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She said that while the changes may seem “counterintuitive,” FICO must believe that they result in a more reliable product, because they are betting their business on it. 

“At the end of the day banks and all lenders want the most predictive score,” she said. “If it’s not predictive, they won’t use it.” 

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