Medical debt is different. Typically when consumers borrow money, they can consider how much they’ll owe, shop around for the best interest rate, and usually have at least a little breathing room to reassess whether the goods or services they want to purchase are worth going into debt for in the first place. All that goes out the window, however, if your child is rushed to the emergency room in need of life-saving treatment.
As Consumer Financial Protection Bureau director Richard Corday explained in May:
When people fall ill and end up at the hospital with unexpected bills, they may not have the money to pay for the doctors, procedures, and medicine. Sometimes insurance does not cover everything. Sometimes they do not know what they owe because of how complicated the billing process can be. Other times they may not even know they owe anything, thinking that their insurance will cover the bill. Sometimes the debt is caused by billing issues with medical providers or insurers. Complaints to the Bureau indicate that many consumers do not even know they have a medical debt in collections until they get a call from a debt collector or they discover the debt on their credit report.
As a result, the fact that someone has difficulty paying their medical bills may not be an accurate reflection of their credit worthiness when it comes to paying other types of debts.
The Federal Reserve raised this concern a decade ago. But it took the CFPB to substantiate the misgivings about medical debt and quantify the problem. In a recent study, the agency analyzed five million anonymous credit records, looking at how well a common credit score predicted a consumer’s future likelihood of paying back debt. They found that credit scoring models tend to penalize consumers too heavily for medical debt, underestimating the creditworthiness by ten points for consumers who owe medical debt and by up to 22 for consumers who have medical debt that went into collections before being paid off. As a result, consumers with medical debt—even debts that are paid off—may be turned down for loans, or have to pay higher interest rates when they do get credit.
This is no niche issue: medical debt is exceedingly common. According to credit bureau Experian, 64.3 million Americans—more than a quarter of all 220 million U.S. residents for whom a credit history exists—had at least one medical collection on their credit report as of July 2014.
The good news? Good research can change the world. The Fair Isaac Corporation, developers and marketers of the frequently used FICO credit scoring system, announced last week that they would change their scoring model to give less weight to medical bills and would exclude bills on collections that had been fully paid-off. Over time, millions of American consumers will pay less on new mortgages, student loans, credit card bills, and car loans—with the lower rates better reflecting their actual creditworthiness. While I have seen no acknowledgement from FICO that they were influenced by the CFPB’s study, it’s difficult to believe the timing is entirely coincidental.
By raising awareness about the shortcomings of letting medical debt drag down credit scores and providing the data to show that the impact, the CFPB again acted to make the financial marketplace a bit more fair to consumers.