Commentary by Nabil Captan
We all know that when a person has a poor credit profile, he or she is less likely to buy a home. Many consumers remain without access to affordable credit and more importantly, no access to the American Dream of homeownership. We continue to witness people’s hard work being wasted to pay unnecessary higher interest rates and fees to finance their debts, denying them the prospect to save for a down payment on a home.
Furthermore, following the recent recession, many lenders have only approved the best borrowers. Those few others who struggled to get a loan with a low score continue to pay, for life, thousands of dollars more in higher interest cost. According to a survey by the Consumers Federation of America in 2007, consumers could save 20 billion dollars a year in finance charges if they improve their credit score by a mere 30 points.
Looking at the surge of today’s consumers borrowing and the rise of sub-prime lending again, this number will most likely double to 40 billion as we approach 2015.
Fair Isaac Corporation (FICO) recently issued a press release regarding their upcoming credit scoring model FICO09, available to credit bureaus this fall and later this year to creditors/lenders. One of the most important changes of the new model is an unprecedented shift in the treatment of a collection account and in particular, a medical one.
Presently, 90 percent of all financial institutions use the FICO scoring models when making credit decisions. Existing FICO scoring models treat a collection account as a very negative event when weighing financial risk. The impact on an individual’s score differs, depending on the score before the collection event appears. The starting score is used as an indicator when assigning this particular risk. For example, a consumer with a 660 FICO score might lose 30 to 50 points, however, a consumer with 780 FICO score might lose 90 to 110 points. It’s hard to digest the logic that a person with the better score is more negatively impacted. However, the most likely rationale is that a person with the lower score had previous challenges in managing debt and therefore, presents a higher risk to a lender.
According to the Fair Credit Reporting Act (FCRA), a collection account remains on a consumer’s credit report even if it’s paid, for seven years and six months from the date the account was originally 30 days delinquent. That’s not changing. However, the negative weight in determining today’s personal financial risk is changing for the benefit of the consumer.
The new FICO09 changes are easy to understand and put in plain words. When FICO09 is used by a creditor/lender, any paid or settled collection account is not considered in the calculation of the credit score. In addition, the new scoring model will assign less negative weight to unpaid medical collections. Again and as above, the starting score plays an important factor in determining its negative impact on someone’s credit score.
According to Experian, one of the three national credit bureaus, about 106.5 million consumers have a collection on their credit report, and about 64.3 million consumers have a medical collection. Lastly, 9.4 million had no balance—meaning their credit score will increase by 25 to 30 points, even though that collection remains on their report.
The statute of limitations for a creditor to legally sue to collect a debt varies from state to state. In California it is four years. However, a bad debt, regardless of its age, can be sold many times over until collected. A consumer turning a blind eye on a debt will only make it grow, except in a case of a bankruptcy, which carries a huge blow to any consumer’s future borrowing potential. Ideally, a late payment should never turn into a collection account. Furthermore, it is important for a consumer to stay away from credit repair companies’ services. It is safer to deal directly with the original creditor or collection agency to settle a debt, and this effort will most likely give a consumer a faster and sure result.
As real estate professionals, we need to recognize that today’s mortgage lenders continue to use the 2004 Classic FICO Score being offered by the three CRAs (FICO version 2 by Experian, FICO classic 04 by Transunion and Beacon 5.0 by Equifax). Even a small increase in borrowers’ credit scores can change the outcome of thousands of loan applicants. The changes, if applied, will definitely bring more homebuyers into the market and improve their chances at homeownership.
What can we do as real estate professionals? It’s simple, if our intended function to enhance the accessibility to homeownership and grow our businesses, we need to act now to expedite the adoption and implementation of FICO09. Change of hearts and minds start at the top, therefore, we must start the conversation with our leadership at the National Association of REALTORS® and other organizations to lobby Fannie, Freddie, FHA, VA, and the many mortgage lenders out there for a speedy application and transition to FICO09.
Nabil Captan is a nationally recognized credit-scoring expert, educator, trainer, author and producer. He is an instructor with the California Association of Realtors and is the creator of The Credit DVD series. For more information, please visit www.nabilcaptan.com.
Copyright 2014 Nabil Captan, Captan & Company. All rights reserved.