September 8th, 2014
The Fair-Isaac Corporation, one the leading providers of credit score calculation software, recently announced an update to its model.
The new calculation method is called FICO Score 9 and could help many consumers improve their credit rating. In the update, two factors are excluded from an individual’s score: delinquent balances that were settled or paid off and collections related to medical bills. The Wall Street Journal reported the change is anticipated to cause a rise in consumer lending.
“It expands banks’ ability to make loans for people who might not have qualified and to offer a lower price [for others],” Nessa Feddis, senior vice president of consumer protection and payments at the American Bankers Association, told the Journal.
The source said the current system for creating FICO scores can at times give as much weight to collections as it does bankruptcies and foreclosures. This fact is particularly damaging in the instance of a consumer who is unaware his or her insurance company isn’t picking up the bill for a medical expense and eventually issued a collections notice. These instances can remain on a credit report for up to seven years, which can hinder consumers’ homebuying goals for some time if they cannot improve their credit scores in other ways.
Getting homebuyers an affordable mortgage
A note from MGIC, a private mortgage insurance company, said FICO Score 9 will expand mortgage credit, HousingWire reported. The update loosens underwriting standards, thereby providing a benefit to consumers on two fronts: some previously ineligible individuals can get a mortgage, and those who were already qualified can get more favorable loan terms, such as a lower interest rate. This advantage could amount to thousands of dollars saved.
One group that stands to see the greatest benefit from the new calculation is those consumers who are not far from having good credit. Given the prevalence of medical bill delinquency in the U.S. – MGIC said these expenses account for more than half of unpaid collections on credit reports – FICO Score 9 could be the tipping point.
When can consumers see the benefits?
MGIC’s note acknowledged there are still some details that need to be worked out before FICO Score 9 can see widespread adoption. Furthermore, it isn’t clear whether lenders will use the new calculation.
According to the Washington Post, it may be some years before consumers see the expected benefits. The obstacle is that Fannie Mae and Freddie Mac, which guarantee most mortgages in the U.S., have already said they will not use FICO Score 9 in the near future. Given the high volume of loans backed by the government-sponsored entities, many major banks and mortgage companies are not ready to make the transition. There’s also the high cost of switching to the new system.
The Post said Fannie and Freddie are still mulling over whether to use FICO Score 8, which is six years old. However, the benefits of the new calculation shouldn’t be ignored despite the lack of rousing support. Chiefly, an applicant whose only credit issue is an unsolved medical debt can see his or her score increase by a median of 25 points.
“None of this detracts from the merit or potential value to consumers of FICO’s new score,” the Post reported. “The company says that by separating out medical-debt-collection issues – which are negatives in millions of consumers’ credit files – from other types of collection actions, the FICO 9 model will more fairly rank the actual risks posed by some applicants compared with others.”