New rules for credit scores may help many people get a better mortgage

The company behind the most widely-used credit score in America has announced three major changes to how it calculates consumers’ scores – and they could potentially help millions of people to get a better rate on a mortgage.

The so-called FICO score is used throughout the lending industry. A new version – called FICO 9 – has now been introduced, and it includes these changes:

(1) A limited credit history is less of a problem. Currently, if people don’t have much of a history of borrowing money – because they’re young and just starting out in life, or because they have simply chosen not to rely heavily on credit cards, auto loans, etc. – this is treated as a negative. Such people usually get lower credit scores because they haven’t established a track record of handling credit wisely.

Under FICO 9, though, a limited credit history will no longer be treated as a strike against you. Rather, the company will look at a person’s payment history for other types of obligations – rent, cable, Internet, phone, utilities, and so on – and assign a score based on the person’s track record of regularly paying these types of bills on time.

(2) Medical debts are less of a problem. Under the current system, overdue medical debts are treated the same as any other overdue debt, such as mortgages or credit cards. Under FICO 9, though, overdue medical debts will be treated as less important than other types of debts.

This could result in a 25-point increase in credit scores for people who have unpaid medical debts but no other unpaid debts, according to the company.

The number of people who have unpaid medical bills has been increasing dramatically lately. According to the Experian credit bureau, about 64 million Americans currently have a medical collection on their credit report.

The change is occurring because FICO believes that medical debts aren’t a good way to judge a person’s ability or willingness to use credit responsibly. For one thing, unlike monthly credit card or auto loan payments, medical expenses are often large, unforeseen bills that consumers couldn’t reasonably have been expected to budget for.

Also, FICO says that people often assume their insurance company will pay a bill, and don’t get much notice if the bill later goes unpaid by the insurer. As a result, many times people aren’t even aware that there’s a problem by the time a medical bill goes to collection.

(3) Paid-off delinquencies are less of a problem. Currently, if someone misses a payment or a debt goes to collection, this will hurt the person’s credit score for many years to come – even if the person later pays the bill or reaches a settlement with a collection agency.

Under FICO 9, though, old delinquencies won’t be considered in calculating a person’s credit score if the debt has been paid off in full or settled.

The rationale is that people sometimes miss their payments due to circumstances beyond their control – such as losing a job – but the fact that they’ve taken steps to make good on the debt shows that they still have an intent to pay their bills on time.

(You should note, though, that these older debts will still show up on your credit report, so while they won’t affect your score, a lender could still find out about them and take them into account.)

Taken together, these three changes will mean better FICO credit scores for millions of Americans. This should help many people get better rates on a mortgage, or qualify for a mortgage when they otherwise couldn’t do so.

However, this won’t happen automatically. While FICO scores are considered in about 90% of overall consumer credit decisions, banks and other mortgage lenders can choose for themselves how they use the scores, and whether they want to “upgrade” to FICO 9 or use an older FICO version.

A large number of banks will probably follow the lead of Fannie Mae and Freddie Mac, which currently use an older version of FICO. Fannie and Freddie both say they’re studying FICO 9, but haven’t made any decisions yet.

FICO 9 might be adopted first by lenders who issue “jumbo” mortgages or otherwise keep mortgages on their own books, rather than selling them to Fannie and Freddie.

It appears FICO 9 is being adopted more rapidly by credit card issuers, auto lenders, and other types of consumer credit providers. At a minimum, this could help borrowers obtain and use other types of credit, which could boost their FICO scores even under the older versions.