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.
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 consumerfinance.gov.