Medical debts that unsettle the housing score

Are medical bill collection accounts buried away inside millions of consumers’ credit files — even bills that were fully paid or settled years ago — functioning as a drag on the housing market?

That might sound far-fetched, yet some credit and mortgage industry experts say negative medical collection records are playing a little-recognized but significant role in depressing otherwise creditworthy loan applicants’ scores. Lower scores, in turn, are disqualifying borrowers from getting mortgages in today’s toughened underwriting climate or forcing them to pay higher interest rates, fees and down payments.

According to a 2008 study by the non-profit Commonwealth Fund, an estimated 28 million Americans were contacted by collection agencies on medical debt issues during a two-year period and 72 million reported difficulties in paying outstanding medical bills.

Now a bipartisan group in Congress is sponsoring legislation that would limit the credit score impacts of paid-off and settled collection accounts that sometimes are the product of disputes and botched record-keeping by insurance companies, hospitals and doctors.

Titled the Medical Debt Responsibility Act, the bill would require the three national credit bureaus — Equifax, Experian and TransUnion — to expunge medical collection records of $2,500 or less from files within 45 days of their being paid or settled. Currently, by contrast, paid-off collections can remain in files for as long as seven years, exerting their heaviest negative impacts on consumer scores during the initial two years. The bill is co-sponsored by Reps. Heath Shuler of North Carolina, Don Manzullo, of Illinois, and Ralph Hall, of Texas.

Craig Watts, director of public affairs for Fair Isaac, developer of the FICO score that is widely used by mortgage lenders, confirmed that “the mere presence of a collection account on the credit report” has an impact on a person’s score. The amount of the collection generally has only a “minor” effect, and the nature of the account — auto loan, credit card, medical bill or whatever — is not a factor. In other words, collections are collections and signify nonpayment of a debt that forced a creditor to pursue the debtor.

Critics charge, however, that medical bills are different from other types of credit accounts since often the consumer does not choose voluntarily to spend money but is forced to do so by uncontrollable events such as illness or accidents.

Terry Clemans, executive vice president of the National Credit Reporting Association, whose members prepare a large percentage of the reports used by mortgage lenders, says the negative impacts of collection accounts on a borrower’s scores vary, but in extreme cases can be “in the high double digits or even more than a hundred” points.

“We see this all the time,” Clemans said. ” It’s a serious problem” because many of these collections stem from run-of-the-mill disagreements over co-pay amounts with insurers or billing issues with doctors that ultimately were paid in full or settled. But because hospitals and doctors tend to quickly hand over unpaid or disputed bills to collection agencies — who then report their actions to the national credit bureaus — what should have been a routine matter turns into a long-term scar on a consumer’s credit file.

Rodney Anderson, executive director of Supreme Lending, a national mortgage banking and brokerage firm headquartered in Dallas, said he and his staff regularly encounter borrowers who are unaware of medical collection accounts on their credit files that depress their FICO scores and increase total loan costs by thousands of dollars. In one case, a borrower had a $150 unpaid medical collection item that cost him $1,500 extra on upfront points on a Fannie Mae conventional mortgage. Anderson’s firm conducted a survey covering 1,700 recent home mortgage applicants and found that 776 “had at least one medical collection” depressing their scores.

The idea of Congress intervening and requiring deletion of medical bill records from national credit files does not sit well with everyone, however. Though the credit bureaus had no immediate comment on the legislation, their trade group, the Consumer Data Industry Association, opposed a similar bill that passed the House last September. The association said it is still studying the current bill.

Fair Isaac, for its part, recently posted on its blog a warning against “subjective tinkering” with credit scores. “When lenders… are prevented from seeing these negative records,” the company said, “[they] are likely to loan to borrowers who are riskier than they appear.”

Where’s this all headed? It’s a complex issue, with solid arguments on both sides. Don’t be surprised if the House passes it this year. But if the big banks weigh in against it, look for it to have a much tougher time getting through the Senate.

Ken Harney is a syndicated real estate columnist.