Study Finds Credit Scores Underestimate Creditworthiness for Consumers Who Owe and Repay Medical Debt
WASHINGTON, D.C.—(ENEWSPF)—May 20, 2014. Today the Consumer Financial Protection Bureau (CFPB) released a research report that found consumers’ credit scores may be overly penalized for medical debt that goes into collections and shows up on their credit report. According to the study, credit scoring models may underestimate the creditworthiness of consumers who owe medical debt in collections. The scoring models also may not be crediting consumers who repay medical debt that has gone to collections.
“Getting sick or injured can put all sorts of burdens on a family, including unexpected medical costs. Those costs should not be compounded by overly penalizing a consumer’s credit score,” said CFPB Director Richard Cordray. “Given the role that credit scores play in consumers’ lives, it’s important that they predict the creditworthiness of a consumer as precisely as possible.”
The study, “CFPB Data Point: Medical Debt and Credit Scores,” can be found at: http://www.consumerfinance.gov/reports/data-point-medical-debt-and-credit-scores/
Consumers’ three-digit credit scores are based on information in their credit reports, compiled by credit reporting agencies, also called credit bureaus. These scores play an increasingly important role in the lives of American consumers because most lenders decide to grant credit and set interest rates based on them. When overdue debt goes to collections and ends up on a consumer’s credit report, it decreases a consumer’s score. This means lenders are likely to take more caution when lending money because the consumer is perceived as less likely to pay it back on time.
According to a study by the Federal Reserve Board, over half of all collections on credit reports are associated with medical bills. The vast majority of medical debt reflected on credit records is reported by third-party collection agencies. In some instances, the consumer may not even be aware of a debt that has been sent to collections or that it is on their credit record. A collection account generally can stay on a report for up to seven years.
Many current credit scoring models do not differentiate between medical and non-medical debt in collections. This is true even though medical debt is different than other unpaid bills reported by collection agencies, such as unpaid phone or utility bills. Medical debt can result from an event that is unpredictable and costly. Sometimes the debt is caused by billing issues with medical providers or insurers. Complaints to the CFPB indicate that many consumers do not even know they have a medical debt in collections until they get a call from the collections agency or they discover the debt on their credit report.
Today’s study considered 5 million anonymized credit records from September 2011 to September 2013 to assess how well a common credit score predicted a consumer’s future likelihood of paying back debt. To do that, the study looked at the credit histories and scores of consumers in September 2011 and then examined their actual loan payment patterns over the next two years.
The study found that credit scoring models have not been considering medical debt as well as they could be. It found that if the credit scoring models accounted differently for medical debt in collection and medical debt that is repaid by the borrower, the models could be more precise. Specifically:
Credit scores may underestimate creditworthiness by ten points for consumers who owe medical debt: Treating medical and non-medical debt that goes to collections the same overly penalizes some consumers by giving them lower credit scores. Specifically, the study found that consumers with medical debt generally paid back their loans or bills on par with consumers with scores about ten points higher. Allowing for different treatment of medical and non-medical collections in credit scoring models may increase the scores of consumers with medical collections and improve credit scoring.
Credit scores may underestimate creditworthiness by up to 22 points after paying off medical debt: Traditionally, credit scoring models have not accounted for repayment of medical debts in collections. The study found that consumers who subsequently paid medical debt that had gone into collections were more likely to pay back their debts, on par with consumers with scores 16 to 22 points higher. Allowing for different treatment of paid and unpaid medical collections would likely result in increased scores for consumers who have paid their medical collections in full.
For consumers with lower credit scores, especially those on the brink of what is considered subprime, a ten- to 22-point difference can affect their interest rates and ability to borrow credit. Over time, the score difference could end up costing a consumer tens of thousands of dollars on large loans like home mortgages.
In 2012, the CFPB released a study examining credit scores that compared credit scores sold to creditors and those sold to consumers. Later that same year, the CFPB released a report on the consumer experience with the three largest nationwide credit reporting companies. The CFPB accepts consumer complaints about credit reporting.
The CFPB is the first federal government agency that supervises consumer reporting companies.
Prepared Remarks of Richard Cordray, Director of the Consumer Financial Protection Bureau, Medical Debt Study Press Call, Washington, D.C., May 20, 2014
Today the Consumer Financial Protection Bureau is releasing a study on how the collection of medical debt affects a consumer’s credit score. What we found is that consumers’ credit scores may be overly penalized for medical debt that goes into collections and shows up on their credit report. This is because credit scoring models may be underestimating the creditworthiness of consumers who owe and pay back medical debt in collections.
Credit reporting plays a critical role in consumers’ financial lives. Credit reports contain detailed information about a person’s financial history and use of credit. Credit scores are numbers that are used to predict whether a consumer is likely to pay back a debt at any given time. A score is created by applying a mathematical formula to the information in a consumer’s credit report about how debts have been paid in the past and other information such as usage of available credit. The formulas are created by looking at how other people with similar credit files have paid their bills over time. Credit scores can affect people’s eligibility for credit cards, car loans, and mortgage loans – and often affect how much they have to pay for those loans.
When overdue debt goes to collections and ends up on a consumer’s credit report, it decreases a consumer’s score. This means lenders are likely to take more caution when lending money because the consumer is perceived as less likely to pay it back on time.
According to a study by the Federal Reserve Board, over half of all collections on credit reports are associated with medical bills. Third-party collection agencies, collecting unpaid bills for hospitals, doctors’ offices, testing labs, and other medical service providers, typically furnish this information.
But in many ways, medical bills are unusual. When you take out a loan, typically you know how much you will owe and the interest rate you will be charged up front. But with medical costs, you have less visibility. Costs are often unknown until after treatment. Choice is a grey area for consumers when they get sick or need a medical procedure quickly.
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.
Our study today looked at 5 million credit records, stripped of any personally identifiable information to protect the privacy of consumers. We used data from September 2011 to September 2013 to assess how well a common credit score predicted a consumer’s future likelihood of paying back debt. We evaluated how the consumers performed on their credit obligations over this two-year period, relative to other consumers with the same credit scores.
The study found that credit scoring models have not been evaluating medical debt as well as they could be. It found that if the credit scoring models accounted differently for medical debt in collections and medical debt that is repaid by the borrower, the models could be more precise.
By examining how consumers actually paid back debts over a two-year period after the overdue medical debt showed up on their credit reports, we found that their credit scores may have underestimated the creditworthiness of consumers who owe medical debt in collections by about ten points. This tells us that having a medical debt in collections is less relevant to a consumer’s creditworthiness than having an unpaid cell phone bill or overdue rent. Treating medical and non-medical debt identically lowers some consumers’ scores by more than is warranted given their observed likelihood of repaying loans. In short, scores could be more predictive if they treat medical debt and non-medical debt differently.
Our second finding is that credit scoring models may understate the creditworthiness of consumers who have repaid medical collections in full. This is because many credit scoring models do not change a consumer’s credit score when a medical collection is paid. Based on the way consumers who repaid their debts performed on their loans, we found that credit scores may underestimate these consumers’ creditworthiness by a median of 16 to 22 points.
These point differences may not matter as much to consumers who have very high credit scores because they may still be able to qualify for loans and the rate they pay may not be affected. But for consumers with lower scores, such as those on the brink of being classed as subprime, these differences can be more significant. They may cause consumers to be denied a loan altogether or they could cost tens of thousands of dollars over the life of a home mortgage.
Today’s study highlights the importance of reviewing credit reports, since medical debt that consumers do not even know about can be damaging their credit scores out of proportion to their actual creditworthiness. Federal law gives consumers the right to review their credit report free of charge once a year with each of the three national credit reporting companies, in order to verify the accuracy of the information. To help educate consumers about their credit reports and encourage them to review their reports, some credit card companies are now providing credit scores and related educational information to their customers on a monthly basis. The Consumer Bureau is urging more widespread adoption of this approach.
As a data-driven agency, the Consumer Bureau believes in informational studies like today’s Data Point. And as the first federal government agency to supervise the larger players in the credit reporting market, we believe we can play a positive role in identifying and resolving risks to consumers that arise within this system.
Given its enormity, given its influence over people’s lives, and given its broad impact on our overall economy, there is undeniably much at stake in ensuring that credit reports and credit scores are working properly for both consumers and creditors. Careful and accurate treatment of medical debt is deserving of greater attention. Thank you.
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The Consumer Financial Protection Bureau is a 21st century agency that helps consumer finance markets work by making rules more effective, by consistently and fairly enforcing those rules, and by empowering consumers to take more control over their economic lives. For more information, visit www.consumerfinance.gov.
Source: consumerfinance.gov
