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Part 2: What is Credit Reporting, and How Does It Harm People with Medical Debt?
Accessing and maintaining good credit is essential to achieving economic mobility. However, a derogatory mark on a credit report can likewise significantly harm one’s life. When an individual struggles to pay off medical debt, the resultant poor credit report can wreak havoc on finances. But to understand the risk to consumers, we must first understand: what are credit reports, and how do they work?
A credit report is a record of a consumer’s credit history and current status of debts. It is designed to signify the consumer’s creditworthiness to potential lenders and summarizes elements of “credit history,” which can include such items as credit card activity, loans, bankruptcy, and outstanding debt, including any medical debt, legal liabilities (if the individual has been sued), and more. A credit report is compiled by a credit reporting agency (CRA), also known as a credit bureau. Banks, lenders, and collection agencies send information about a person’s debt to a CRA. There are three primary CRAs: Experian, Transunion, and Equifax (also called the “big 3.”) Each of these companies take all of one’s credit history and compile it into a credit report.
A credit score, in contrast, is a three-digit number that is used to approximate credit risk, i.e., the likelihood a consumer will make future payments on time, for lenders. Credit scores are created by credit score providers, like FICO and VantageScore, which take the information included on a credit report and generate scores based on proprietary algorithms.
When a CRA is alerted to a new consumer debt, that information goes onto the person’s credit report. In turn, the CRA sends that information to a credit scoring provider. When someone like a lender or landlord checks a person’s credit score, they request it from a credit scoring provider.
When debts go unpaid, they are passed off to a debt collector, a process often referred to as “going to collections.” Once a debt is reported as “in collections,” the CRAs then send that information to credit score modeling companies, which can have devastating impacts on a credit score. Notably, creditors, lenders, and collections agencies aren’t obligated to report debts to all three CRAs. One person’s credit report may look different depending on which CRA generated the report.
Credit reports may be accessed by a variety of entities from banks and lenders to landlords and utility companies. Even some employers use credit reports in hiring decisions, ostensibly to look for risk of theft and irresponsibility. As a result, bad credit can bar one from landing a job, buying or renting a home, being offered affordable rates on car loans and insurance premiums, and even accessing essential utilities.
Medical Debt and Reports
Medical debt should not be included on credit reports for myriad reasons. A Consumer Finance Protection Bureau (CFPB) study found that when credit reports include medical debt, credit scores significantly underestimate consumers’ creditworthiness. Furthermore, CRAs estimate that only 0.07% of medical debt reported to them comes from medical providers, while the rest are from collection agencies. No other industry operates such that only negative information is reported to CRAs. So, if a person is making payments to their medical provider, there is a slim chance that person would see positive impacts on their credit report from on-time payments the way other debt payments would. In all but rare instances, medical debt negatively impacts a person’s credit report.
The scale of the problem is exacerbated by a system which is highly prone to errors and false claims of debt. The Consumer Reports study “A Broken System: How the Credit Reporting System Fails Consumers and What to Do About It” found that 34% of study participants found at least one error on their credit reports. Not only does medical debt negatively skew credit reports, but these harms are often based on wrong information.
There are two main credit score algorithms that are generally used by lenders and creditors: FICO and VantageScore. Recently, VantageScore made the determination that their newest credit scoring models would no longer consider medical debt in their algorithm. In making this voluntary change, VantageScore cited the low predictive value of medical debts in collections in creditworthiness, and anticipated that millions of consumers would see an increase to their credit score under the new model. While this is a great step for consumers, the vast majority of lenders continue to use FICO scores, older scoring models from VantageScore, or credit scores from other providers.
Starting July 1, 2023, the big 3 CRAs will voluntarily remove medical debt of less than $500 from credit reports. They will also wait 12 months before reporting other medical debt on credit reports. Though these appear to be laudable changes, some consumers will still be left behind. According to an analysis by the CFPB, people who are low-income, BIPOC individuals, and people with disabilities or chronic illnesses will receive less relief. People of color are less likely to have medical debt under $500 and will be less impacted by the industry changes.
Ultimately, while this policy seems like a positive step, it actually just perpetuates inequities on who is impacted by medical debt and leaves millions of vulnerable Americans behind. These voluntary changes don’t apply to other credit reporting and credit scoring agencies, and there are no guarantees that these changes will be permanent. A CCLP-led bill, House Bill 23-1126, would remove all medical debt from credit reports improving access to housing, employment, credit, and more for over 700,000 Coloradans. These protections would make the changes industry-wide in Colorado and would be a long-lasting solution. HB23-1126 is crucial to fill in the gaps of the voluntary changes made by the credit reporting industry so that no Coloradan is left behind.
Stay tuned for the next post in the medical debt series which will cover the impacts medical debt has on people.
For more information on HB23-1126 click here.
Click here to read Part 1: Medical Debt and Credit Reporting: A CCLP Deep-Dive.
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