Wouldn’t it be great if credit unions could boost the overall lending portfolio without creating more undue risk?
On Thursday, Fair Issac Corp. announced changes to its FICO score calculations it will release later this year, called FICO 9. Among the changes, FICO calculations will no longer include any record of a consumer failing to pay a bill that has been paid or settled with the collection agency. Additionally, the scores will give less weight to unpaid medical bills that are with a collection agency.
As of July, and according to Experian data reported by the Wall Street Journal, approximately 64.3 million consumers in the United States had a medical collection on their credit report. 9.4 million of the 106.5 million consumers with a collection on their report will not be penalized under the new score system.
Under the current system, these collections impact credit scores as much as foreclosures and bankruptcies despite the differences in size.
What does this mean for credit unions?
There are two schools of thought. First, this good for both borrower and lender. Lenders don’t like taking undue risk. All things being equal, they’d rather make a loan to someone with a higher credit score. By altering these elements, credit scores will likely rise and along with them the pool of desirable borrowers.
Critics, including the CFPB, have said current credit scoring models put undue weight on unpaid medical debt. The new model, they argue, represents a more accurate picture of risk. And as even small shitfs in credit score can impact interest rates and application decisioning, the changes should lead to better rates and more approved loans. A win for both the borrower and lender.
The second school of thought offers a gloomier take. Loosening the definition of credit score calculation inflates the overall pool of potential borrowers and gives attractive credit scores to more individuals. Does this adequately reflect holistic risk?
It’s estimated that 75 million people in the United States had trouble paying their medical bills as of 2012. That’s up from the 58 million reported in 2005, according to a report from the Commonwealth Fund. If less weight is given to unpaid medical bills, then consumers who might already be in financial trouble can use their seemingly good credit to put themselves further into debt.
As FICO adopts the changes, credit unions would do well to take a look at their decisioning processes. Will you accept more borrowers at better rates? Will you supplement this new credit score with factors that give you a more accurate holistic view? How will you ensure a borrower’s personal finances aren’t structured in a way that will lead to losses months down the line?