We have some great news to report as Fair Isaac Corporation (otherwise known as FICO) has just announced that the FICO credit scoring will be changed to reflect how unpaid debt is calculated. This will be launched this Fall as FICO 9.
Currently, lenders utilize a FICO score in roughly 90% of all mortgage lending decisions. Since 2011, the average credit score has been on the decline. This can be attributed to a variety of reasons including a growth in health care debt. One recent study projected that 20 percent of all Americans between the ages of 19 and 46 will struggle to pay medical bills this year alone with an estimated 64 million Americans having some sort of medical collection on their credit reports.
Unpaid medical bills have been disproportionately affecting consumers’ credit scores through the current (and past) FICO models according to the Consumer Financial Protection Bureau (CFPB). The three major U.S. credit bureaus (Equifax, TransUnion and Experian) all utilize the FICO scoring system as a foundation for their credit reports, which has gone through nine modifications with this latest algorithm update.
Drum Roll Please
The main change is that if a borrower settles debt as opposed to allowing it to go unpaid, they get rewarded with a higher credit score. As an example, if someone pays off unpaid debt then the credit score could increase by 25 points. This is a big deal in the housing market as many Americans have been unable to obtain good interest rates on home loans because of weak credit scores. With tighter restrictions on lending so many have been shut out of the market. The changes to FICO scoring will open the door to home ownership for many. While the change seems relatively small, it will have a huge impact on credit scores and also allow banks to lend out more money without escalating their risk.
“In recent years the [credit score requirement] has been dialed so tightly that only fairly upper-tier consumers were able to qualify for a loan,” says Lawrence Yun, National Association of REALTORS®’ chief economist. “We’re looking at people who are currently being denied potentially being offered a mortgage because of this.”
FICO, the nation’s most popular credit-scoring system, had recently notified lenders that their high credit scoring cutoffs were stricter than necessary and further urged lenders to lower the minimum credit score requirements of borrowers.
The FICO Scoring System
While FICO scores range from 300 to 850, the average FICO score for a closed mortgage in June was 728. Some have blamed the credit scoring system as one of the main reasons for the housing market crash back in 2007/08. Many say that this latest adjustment to the medical bills is a step in the right direction to creating more fairness in credit scoring. While the change doesn’t remove the unpaid debts from the credit report, it does help the score. As such, the unpaid debts will still be factored into the debt-to-income (DTI) ratio for lending institutions qualifying borrowers.
What This Means for You
The bottom line is that this will help many Americans qualify for more loans, gain better interest rates and ultimately save more money by having a lower payment on a loan. Be on the lookout in the coming months as your three digits (also known as credit score) may be increasing and thus you will have better creditworthiness. But beware as some lenders are predicting that it may take a year or more for the impact of the credit score improvements.
With over 200 million U.S. adults that have a FICO score and credit report, this is a big deal!
Homes For Sale By Ownerwe buy houses, Changes To FICO Scoring And How Your Three Digits May Increase