One of the great battles raging in the underworld of consumer credit is the conflict between what’s best for consumers and what’s best for banks. Consumer advocates argue that anything that isn’t in the best interest of the consumer is, well, bad. Banking trade associations argue that anything that isn’t in the best interest of the bank is bad for consumers because it limits choices and increases costs.
The latest battle is over H.R. 2086, more affectionately known as the Medical Debt Responsibility Act of 2011. The Act, among other things, would require that the credit reporting agencies remove medical collections once they’ve been paid or settled as long as the amount was less than $2,500. This means an almost immediate improvement to your credit scores, unless your credit reports are still awash with other negative information and/or excessive credit card debt.
H.R. 2086 is potentially the second significant blow to the credit reporting agencies and credit scoring systems this year, and we’re only in June. In February the IRS announced new rules, which would likely result in the removal of Federal tax liens from credit reports if the consumer pays them in full. I wrote about the new tax lien rules here.
Is this a good idea?
On the surface, the potential to have paid medical collections removed sounds fantastic, especially for the consumers who had them on their credit reports. But, is it really a good idea for everyone else involved? And at what point do we have to consider the lenders who use this data to make smarter loan decisions?
There’s little honest resistance to the fact that medical collections are, in fact, predictive of elevated credit risk. FICO, who is not in the business of being dishonest, even posts as much on their analytics blog referring to medical collections as being “highly predictive of credit risk for years after the fact.” The real question that needs to be answered is whether or not the removal of a paid medical collection reduces the effectiveness of credit scores and whether or not the lack of that information can be subsidized by something else from a credit report.
The goal of H.R. 2086 seems to be to protect consumers from having medical collections ruin their credit IF they were caused by billing mistakes. How many times have we had to argue about medical bills that were screwed up because of insurance carrier issues? I don’t think anyone would object to the removal of those collections because they are misleading.
Why the $2,500 limit?
It also begs the question…why condition the removal on a $2,500 balance? Isn’t it just as easy to have a $3,000 medical collection caused by billing errors, as it is to have one of $2,000? Why not remove all medical collections once they’re paid? Why the compromise? Was it to make the passage of the proposed legislation more palatable? Last year a similar proposal didn’t have the $2,500 exception.
The proposal would also result in the removal of collections that are the result of consumers not paying their legitimate medical bills. There is simply no way to look at a credit report and identify a medical collection that was caused by an insurance snafu versus one that was caused by the refusal or inability to pay for services. This leaves no options to be more surgical.
Today, paid medical collections (and all other paid collections) remain on the credit report for seven years from the date the account went terminally delinquent with the original creditor, in this case a medical provider. And, ever since a 2003 amendment to the Fair Credit Reporting Act, medical collections have been required to include specific indicators that identify them as being medically related. The insurance industry has not been allowed to use ANY medically related credit report information since that time.
Would you lend to someone with unpaid medical collections?
I think an interesting exercise would be to put yourself in the position of lending money. And I’m talking about lending YOUR money, not someone else’s money like what mortgage brokers do. What kind of information would you want to see before you let someone borrow $300,000? Would you want to see all of their medical collections or do you think you could make a smart lending decision without it?
Keep in mind that they’re proven to be very predictive of elevated credit risk. So, it’s not like we’re talking about a superfluous piece of credit report information. If you’re struggling with the answer then you just realized that the world of pretend lending is no easier than the world of real lending.
John Ulzheimer is the President of Consumer Education at SmartCredit.com, the credit blogger for Mint.com, and a Contributor for the National Foundation for Credit Counseling. He is an expert on credit reporting, credit scoring and identity theft. Formerly of FICO, Equifax and Credit.com, John is the only recognized credit expert who actually comes from the credit industry. The opinions expressed in his articles are his and not of Mint.com or Intuit. Follow John on Twitter.