Fair Isaac Corp. (FICO) said that it would be changing the way it calculates credit scores by tweaking included parameters. By taking into consideration bills that have already been settled, credits scores can go up, improving an individual's shot at being allowed to take out a loan.
FICO announced that it would be taking a consumer's failure to pay a bill, if the bill has been settled with a collection agency, out of the equation when calculating credit scores while at the same time reducing the weight that unpaid medical bills have. Records from as far back as seven years are factored in when determining credit scores and this has left many with low ratings despite having already settled their dues.
The change is expected to boost lending, especially for borrowers who have been either denied or given high interest rates because of low credit scores. Medical collection affects credit reports for around 64.3 million U.S. Consumers, according to credit bureau Experian.
The new scoring system can increase credit scores by up to 25 points when only unpaid medical debts tarnish an otherwise good credit history. Ranging from 300 to 850 points, credit scores are calculated by using information from Experian, Equifax and Transunion, the three major credit bureaus in the U.S. According to research from the CEB Tower Group, about 90% of the time FICO scores are used to determine loan decisions.
John Ulzheimer, Credit Sesame credit expert and former FICO employee, said that the new system will not really affect whether a loan is approved or denied but rather will determine the kind of rate consumers are given.
"It takes a long time for credit scoring systems to achieve critical mass. It takes years for lenders to gravitate from older versions to newer versions. The changes will only help consumers in as much as the lenders they apply with actually use that new score," he adds.
Fannie Mae, for instance, is one of the many financial institutions that are using the older FICO system, and spokesman Pete Bekel has said that the company is confident in what it uses to as standards to determine if loans should eligible for purchase. The FICO 8 came out in 2008.
FICO's new credit scoring system is the result of the company addressing concerns from regulators and lenders about the prominent role of medical debt in collections. Two years of worth of consumer data were studied and it was determined that unpaid medical debt is not a clear credit risk indicator, prompting the change in the credit scoring system.
Called FICO 9, the new scoring system will roll out later this year.
