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FICO recalibrates its credit scores

The changes could lead to more bank lending and easier credit for some consumers.

By Money Staff Aug 8, 2014 1:10PM

This post comes from AnnaMaria Andriotis at partner site The Wall Street Journal.


The Wall Street Journal on MSN MoneyA change in how the most widely used credit score in the U.S. is tallied will likely make it easier for tens of millions of Americans to get loans.


Fair Isaac Corp. said Thursday that it will stop including in its FICO credit-score calculations any record of a consumer failing to pay a bill if the bill has been paid or settled with a collection agency. The San Jose, Calif., company also will give less weight to unpaid medical bills that are with a collection agency.


The moves follow months of discussions with lenders and the Consumer Financial Protection Bureau aimed at boosting lending without creating more credit risk. Since the recession, many lenders have approved only the best borrowers, usually those with few or no blemishes on their credit report.

The changes are expected to boost consumer lending, especially among borrowers shut out of the market or charged high interest rates because of their low scores. "It expands banks' ability to make loans for people who might not have qualified and to offer a lower price [for others]," said Nessa Feddis, senior vice president of consumer protection and payments at the American Bankers Association, a trade group.


As of July, about 64.3 million consumers in the U.S. had a medical collection on their credit report, according to data from credit bureau Experian. And of the 106.5 million consumers with a collection on their report, 9.4 million had no balance—and won't be penalized under the new credit-score system.


Some critics said that loosening standards could bring losses for borrowers and lenders. "A lot of people really just can't handle credit—you're not really helping them by allowing them to dig themselves into debt," said Howard Strong, a lawyer in Tarzana, Calif., who specializes in consumer-protection class-action lawsuits. "It's like a sharp knife—if you don't know how to use it, you can cut yourself."


Many types of debt, including credit cards, can be discharged in bankruptcy. If borrowers fall behind, they could file for bankruptcy and cause lenders to suffer losses, Mr. Strong said.

A Consumer Financial Protection Bureau spokeswoman declined to comment on the changes by Fair Isaac.


Under the current system, collections can impact credit scores as much as foreclosures and bankruptcies do. But the infractions are often small. Borrowers can be on time paying their debts, for example, but thrown by a medical emergency.


Collections stay on credit reports for as long as seven years, even if a borrower has paid off that balance and remained up-to-date on other debts.


Some experts said the new model for FICO scores walks a fine line: It loosens standards without overstating the creditworthiness of borrowers. Fair Isaac said it ran studies to determine how likely borrowers are to repay their debts if they had a stellar credit record with the exception of such collections.


Consumers often are unaware that their insurance company isn't paying a medical bill and can end up in default and in collection without knowing it, said Anthony Sprauve, senior consumer credit specialist with Fair Isaac. In contrast, lenders often send repeated notifications to consumers to let them know they have fallen behind.


Most lenders check applicants' FICO scores to help determine whether to extend credit to consumers and what interest rate to charge. Fair Isaac will begin rolling out the new scoring model, named FICO 9, to credit bureaus this fall and to lenders later this year.


More than half of all debt-collection activity on consumers' credit reports comes from medical bills, according to the Federal Reserve. Such activity results in lower credit scores for consumers, meaning that lenders are more likely to be cautious in extending credit.


The number of U.S. consumers struggling with medical debt has been surging. As of 2012, 41 percent of U.S. adults, or 75 million people, had trouble paying medical bills, up from 58 million in 2005, according to a report released last year by the Commonwealth Fund.


Bank loan document © Southern Stock Corp/CorbisThe CFPB, in a May report, criticized credit-scoring models used by the financial industry, saying they put too much emphasis on unpaid medical debt and lead to an overly negative view of consumers. CFPB officials say that medical debt is inherently different from other forms of debt because consumers are often unaware of what they owe to hospitals and doctors.


FICO scores have many competitors but are the most widely used. Lenders used them in 90 percent of consumer and mortgage loan decisions, according to a study this year by the CEB TowerGroup, a financial-services research firm. VantageScore Solutions LLC, a rival credit-scoring firm in Stamford, Conn., rolled out a new scoring model in March 2013 that excludes all paid collections.


Fair Isaac releases new scoring models every few years, and it is up to lenders to choose which ones to use. The new score will likely be adopted by credit-card and auto lenders first, says John Ulzheimer, president of consumer education at CreditSesame.com and a former Fair Isaac manager.


Mortgages are likely to lag, since the FICO scores used by most mortgage lenders are two versions old.


The impact of the changes on borrowers is likely to be significant. Accounts that are sent to collections, including credit-card debts and utility bills, can stay on borrowers' credit reports for as long as seven years, even when their balance drops to zero, and can lower their scores by up to 100 points, said Mr. Ulzheimer.


The lower weight given to unpaid medical debt could increase some affected borrowers' FICO scores by 25 points, said Mr. Sprauve.


Even a small move in a borrowers' credit score can change the outcome of a loan application. Most lenders have a minimum credit-score requirement to lend to an applicant, and lenders can deny someone whose score is even one point below the minimum.


Lenders determine the interest rate a borrower will get based on the borrower's credit-score bracket.


For example, borrowers with a FICO score between 760 and 850 get an average interest rate of 3.823 percent on a fixed-rate, 30-year mortgage of $300,000, according to Informa Research Services, a market-research company in Calabasas, Calif.


Borrowers with a 759 FICO score get a 4.045 percent interest rate on the same loan. Over the life of the loan, the 760 borrower would pay $204,650 in interest charges—or $13,764 less than the 759 borrower.


— Alan Zibel contributed to this article.


More from The Wall Street Journal

109Comments
Aug 8, 2014 2:40PM
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I feel like what should really be done is to stop making loan applications hurt your credit score. It's such a PITA when you're looking for a loan. Only when you actually take the loan should it have an effect.
Aug 8, 2014 2:50PM
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I was trying to remember, (and I'm 82 years old) when a government program actually worked.
Aug 8, 2014 3:13PM
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Too bad. I thought they might do something smart like cease punishing people's scores for paying off their credit cards.
Aug 8, 2014 2:55PM
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The credit reporting industry is one of the biggest consumer protection frauds in the US.  The credit lending industry uses that fraudulent reporting scam as the excuse to overcharge for loans using low scores as a justification rather than their own usurious greed.  I dropped the insurance company that kept charging me higher rates because the claim made by the credit reporting industry that: the number of accounts paid as agreed.  Note that they claimed neither high or low number of accounts.  They were all paid as agreed.  All two of them!  As well as all the old accounts I closed out over the past 30 years. I've paid all my bills on time and in full for my entire life.  Basically, the credit reporting industry reported that I paid all my bills on time yet according to the insurance company that didn't rate me the lowest available rates because of the consumer credit report.  I was told I could contact the credit reporting bureau to contest it.  What could I do?  Argue that I didn't pay as agreed?  Or argue that I didn't pay at all?  Give me a break!  I know a scam when I see one!
Aug 8, 2014 2:20PM
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Here comes another real estate crash!

 

If you don't pay your bills you shouldn't be able to get a mortgage.

 

DUH!

Aug 8, 2014 2:16PM
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2007 all over again. Give everyone credit. Why don't the banks just loan every citizen and illegal $100K, no questions asked. Trust us, we'll pay it back...
Aug 8, 2014 2:51PM
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Read between the lines..the lenders are the ones pushing this so that they can justify more loans thus making more money. 2008 lessons apparently wasn't learned.
Aug 8, 2014 3:17PM
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I have a near perfect FICO score. My only issue with the three (3) credit reporting companies is that every time I finish paying-off, say, a car loan, my FICO score always seems to take a steep dip. The only reason for this is because the bank(s) notify the credit agencies my loan account was CLOSED, and from what I've noticed, it makes no difference if the notation also indicates the loan was “PAID ON TIME” or “LOAN PAID OFF.”


Just saying...


Aug 8, 2014 2:30PM
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 So People that work hard, play by the rules, have always done what`s right, Do not live beyond their means, Don't spend what they don`t have, They are now on a level playing field with those who just don`t give a ****, not those that have or had unforeseen circumstances happen to them for a myriad of reasons & can be devastated in an instant, I can empathize with them, but just those who have never done the right thing no matter what and are going to be rewarded for it, what an outstanding idea! Not
Aug 8, 2014 2:06PM
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The credit company is bowing to the politicians. They're setting the game up for more people to get into debt beyond their means and fail again.
Aug 8, 2014 3:13PM
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what a joke.  The entire credit bureau system is a scam to keep the credit bureaus in business.  People stress over their "score" but not one lender uses the score they pay to see.
Aug 8, 2014 2:32PM
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This is long overdue.  Medical collections especially !! Congratulations FICO for doin something for us all.  Most medical collections are Balance Billing or incorrect billings by 3rd party companies who are out of state and never even participated in the medical procedures.  This is way overdue and and excellent move on behalf of us who do pay our bills but are tryin to be cheatded by these bogus collection agencies.  !!!!
Aug 8, 2014 1:37PM
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As America lessons Americans quality of life, so must it lessons it's ability to barrow.

I would not let our politicians manage my fish bowl.

Aug 8, 2014 2:36PM
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"The moves follow months of discussions with lenders and the  aimed at boosting lending without creating more credit risk."  How does lowering the bar not create more credit risk?  Either a person is a good credit risk or a bad credit risk and should enjoy and pay for their credit accordingly.  It's interesting the Government's Consumer Financial Protection Bureau is involved in lowering lending standards.  And, why wouldn't lenders want to increase lending at higher risks if they think the Taxpayer will bail them out when it all collapses again.  This is how we got into trouble in the first place.
Aug 8, 2014 3:06PM
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FICO Scores are designed to help banks make money from their own consumers: charging extra interest and unnecessary fees, citing "poor credit ratings" when there are so many mistakes in the credit report to begin with, let alone poor scores/ratings. On the other had the rich can screw up big then borrow more money from the same banks with lower interest rates to payoff other debts. 


I suspect the change would hardly be noticeable. This is another way of saying we want your money "regardless" keep working and keep paying us. If your unemployed then we want your home, 401K, car, and even your wife!

Aug 8, 2014 3:24PM
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I remember when home values began to level off and drop around 2006-2007 and some banks had trouble qualifying homeowners for equity loans. These bank increased the permissible debt  to value ratio, allowing higher debt despite dropping home values. 

Looking back, we see how well that worked!

Now the banks are going to be able to ignore the weak payment history of many loan applicants, so that they can make more loans.

We are suppose study history so that we don't repeat the mistakes of the past.

I guess the profit is in making loans, not collecting on them!

Aug 8, 2014 3:41PM
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Just like giving kids trophies when they come in last. 
Aug 8, 2014 1:38PM
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Aaaah yes, the predictable cycle of regulations.  History repeats itself - again.  The CFPB takes the bait.  First over-regulation, now its trending toward loose regulation - all to achieve the desired economic results - always late to the show.

Now that r.e. prices are much higher and interest rates too, it makes total sense to loosen the credit standards for people who couldn't qualify at lower prices and lower interest rates.  Somebody explain that math to me. Now that the risk is higher and reward lower, Obama will let the average Joe, that he has been protecting all this time, into the game.  Some friend he is.  Foolish.

The CFPB and Obama screwed the average citizen totally.  Low r.e. prices and interest rates were squandered and went totally to the rich who were the only players allowed to play the game.

Totally predictable.  Totally foolish.  No wonder we're in a civil war.
Aug 8, 2014 3:20PM
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The sub-prime borrowers amaze me - they complain now that the credit standards are too high.


However, when credit standards hit bottom in 2007 and they were given easy loans.- and then defaulted - they then blamed the banks for giving them loans they feel they should not have received....even though they were adults signing a legal contract.


Credit handling is easy - figure out what loan debt you can handle - obtain the loan.....and then pay it monthly until the debt is completed.

Aug 8, 2014 3:56PM
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My home and cars are paid for, screw FICO scores!
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