Do Medical Bills Hurt Your Credit Score?

MarketWatch recently addressed the issue of unpaid medical bills and the effect that those unpaid bills have on one's personal credit. The reader asked if medical bills are treated the same as outstanding credit card debt and whether it affects the FICO score.

According to the MarketWatch reporter, medical bills are treated differently than credit card debt and as a result, "don't always have a direct effect on your FICO score." That's because medical debt is not always reported to the credit bureaus – just the debts that have been sent to a collection agency. And the debt owed for medical bills does not count toward your total debt utilization ratio – that is, how much you owe on your credit card balances compared to your credit limits.

However, your Credit Mama has a few words of caution. Once your unpaid medical debt is forwarded to a collection agency, the debt is very likely to be reported to the credit bureaus. And as a collection debt, it will have a significantly negative impact on your FICO score.

If you are trying to qualify for a mortgage or car loan, a lender will look closely at any unpaid bills, including medical. Most mortgage lenders require that any unpaid bills over $500 (or multiple bills adding to $500) be paid in full before they will lend for a home or investment.

Fannie Mae guidelines generally require that collection accounts (including medical) in excess of $250 per individual account or $1,000 in the aggregate must be paid in full.

Given the current credit crisis, I believe most underwriters will not waive this requirement.

Medical bills are one of the top three reasons people file for bankruptcy, accounting for half of all U.S. bankruptcies. Most frightening is that 75.7% of those whose illnesses led to bankruptcy had insurance at the onset of the illness, according to a study published in the journal Health Affairs.

Bankrate.com suggests contacting the hospital directly to see whether you can qualify for low-income waivers or financial assistance, and researching nonprofit organizations that specialize in helping people with high medical debt to negotiate on your behalf to reduce the balance. Once you get sent to collections, you are dealing with a for-profit company that is not interested in you – just your repayment of the debt.

In case you missed it - a previous post on the new medical FICO scoring system that is being developed.

Fannie and Freddie are Looking at Your Credit Score

The latest numbers released by RealtyTrac, a realty research group, show that more than twice as many homes were headed into foreclosure in the first quarter of 2008 – that's one in every 194 households nationwide. In some states, the numbers are even higher – for example, in Nevada, one in 54 homes received a foreclosure notice.

That trend is expected to continue throughout the year as mortgages continue to adjust throughout the summer and fall. The continued pressure has Fannie Mae and Freddie Mac – who purchase mortgages and bundle them into securities to sell to investors – looking for ways to mitigate their risk.

Once upon a time, just about anyone with a 620 score or better could get a loan with minimal down payment. But new fees are now being imposed on buyers – fees that directly correlate with the buyers' credit score and the amount of money being put down.

These "Loan Level Price Adjustments" (LLPAs) are upfront penalties that cannot be negotiated away by your lender. (They do not impact FHA or VA loans.)

In order to escape these additional upfront costs, your credit score will need to be 720 or better if you are putting down less than a 30 percent deposit on the home.

Here's an example:

If you buy a $250,000 house, putting down $50,000 and borrowing $200,000:

• If your credit score is 720 or higher, there's no fee.
• If your credit score is 680 to 719, you pay 0.5 percent, or $1,000.
• If your credit score is 660 to 679, you pay 1.25 percent, or $2,500.
• If your credit score is 619 or lower, you pay 2.75 percent, or $5,500.

The FICO credit score used by Fannie and Freddie is the middle score generated by the three national credit bureaus. If there is more than one borrower, they will look at the middle score of the borrower that earns the highest income.

The stricter requirements have mortgage lenders calling this the new "predatory lending" formula that will escalate the number of deals that fall through in today's shaky market. Sal Bernadas, president of the Louisiana Mortgage Lenders Association, told the New Orleans Business Journal, "The fact that they're charging new fees to people with 20 percent down and a 680 credit score – there is no statistical reason they need to do that to protect that particular loan from losses."

Bankrate.com says that lenders have the option of converting the fees into higher rates for customers who don't want to pay the cash upfront; however, the end result could mean significantly higher monthly payments.

If you are thinking about getting a mortgage in the upcoming year, you will want to order your FICO credit report and review it carefully. Even small changes can make a big impact on the amount of mandatory fees you will be required to pay. And whether you decide to repair your credit yourself or use a professional agency to optimize your credit, keep in mind that it may take six months or more to get your credit score to the point where you don't have to pay the expensive fees.

View the LLPAs for loans issued after June 1, 2008 with terms of more than 15 years (based on loan-to-value and credit score)