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How to profit from new credit scores

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Roughly one in five U.S. consumers could see their credit score jump this fall thanks to the final phase-in of a three-year-old legal settlement. And that could allow millions to get lower-cost loans and to cut their insurance premiums.

Starting in September, credit bureaus will be barred from including medical debt collections – which mar the credit scores of roughly 20 percent of all Americans – if the debt isn't at least six-months old. Additionally, if a medical debt was eventually paid by insurance, any report of the delinquency must be subsequently removed from the consumer's file.

Coupled with July changes that strip most civil judgments and tax liens from credit reports, millions of consumers could see their credit scores significantly improve. What exactly is happening and how should you react? Here are answers to your questions.

Why are these changes being made? In 2015, the three big credit reporting companies – Equifax, Experian and Trans Union – settled a lawsuit by a group of state attorneys general who contended that inaccurate credit reports were hurting millions of consumers. Without admitting wrongdoing, the companies agreed to phase in a host of changes that would reduce the number of "mixed files" (which blemished the credit report of people with similar names to debt scofflaws) and make a number of procedural changes aimed at improving the accuracy of these reports. The final part of this agreement goes into effect September 15.

How do these changes affect credit scores? Credit reports are different than credit scores. However, every credit score is calculated based on the information provided in a consumer's credit report. Fair Isaac, purveyor of the ubiquitous FICO score, has already changed it's so-called FICO-9 score to reflect a portion of the upcoming credit reporting changes. But stripping consumer files of civil judgments, public liens and certain medical debts will also affect a half dozen other FICO-scoring models, as well as the so-called Vantage score used by some creditors to rate insurance and mortgage risks. 

Why were liens, judgments and medical debts targeted? Mainly because these debts were not always accurately reflected on credit reports. Medical debts, in particular, were a problem for a variety of practical reasons. First, unlike credit card charges, medical debt often resulted from an unplanned event, such as an emergency surgery or illness that might take some time to repay. Doctors and hospitals also had no standard formula for when they sent unpaid debts out for collection, which meant that some consumers were reported as paying tragically late when they were merely a month or two overdue, while others didn't get reported for years. Moreover, slow reimbursement payments by insurers could send medical bills into collection – a damaging credit scar – through no fault of the consumer. Worse, even after the insurer paid the medical bill, the damage to a consumer's credit typically lasted for years.

Additionally, court judgments and liens were rarely updated, so consumers could see their credit suffer from these issues long after the judgments were paid and the liens were released.

What about mixed files? Credit reporting models do not require every bit of data to match before the information was added to a consumer's file. Indeed, some companies that report your payment history to the credit bureaus did not include your name, address, age and Social Security number when they reported a problem. So if you happened to be named after a parent, your data could be mixed up with a parent's because your name and former addresses matched, even though your Social Security numbers and age were different. 

Starting September 15, any company that furnishes credit data to the bureaus must include your full name, address, Social Security number and date of birth, which should decrease the chance that your file could get mixed with someone else's.

What difference does this make? Banks, credit unions, insurance companies, credit card issuers and mortgage firms generally decide what rates to charge you for their products based on your credit score. The lower your score, the higher the perceived risk that you will default on a loan and the higher rate you pay. In many cases, in fact, lenders will advertise that you could get a preferential interest rate if you have "tier one" credit. However, if your credit score causes you to be in a lower "tier," your rate could be higher – often several percentage points higher. And that could cost a fortune in additional financing costs.

For instance, if you wanted to get a 30-year, fixed-rate mortgage, you may be able to secure a 4 percent interest rate in today's market, if you are a top credit risk. However, if your credit score was lower, you might pay 5 percent. At 4 percent, for example, your monthly payment would amount to $1,193.54; at 5 percent, it would jump to $1,342.05 – or $148.51 per month more. Over the life of the loan, that difference amounts to more than $53,000.

Will these changes allow consumers to jump into higher credit tiers? In some cases, yes. But it's tough to know for certain because different lenders set their credit tiers at different levels. For instance, you are generally considered to be in the top credit tier for a car loan if your credit score tops 720. However, you may need to have a score of 740 or higher to get the best rate on a home loan.

What should I do about the changes? The main thing you should do now is start monitoring your credit score. Many web sites and a number of credit card issuers, such as Citibank, Discover, American Express and Capital One, already provide free access to credit scores to their customers. If you don't get free scores now, consider signing onto one of the free-score websites, such as Credit Karma or Credit Sesame. Jot down your current score, then check again in the fall to see if your score is significantly higher.

It's worth noting that your credit score will change incrementally every month, depending on your payment history, how much debt you have outstanding, when you last applied for credit and other factors. It's generally only significant when your score climbs by 20 points or more. That's the sort of change that can push you into a higher (or lower) credit tier.

What if I do see my credit score jump by that amount? Start talking to your lenders, suggests Ed Meirzwinski, U. S. program director of the U.S. Public Interest Research Group. Credit card companies may be convinced to lower your rate with nothing more than a phone call, assuming that your credit situation has improved, he noted.

Auto loans and mortgages can also be refinanced if your credit has significantly improved. However, whether you ought to refinance these loans will depend on a range of factors, including how long you expect to maintain the car or home, current interest rates and whether you have to pay any upfront fees.

Meanwhile, you may also be paying higher rates on your insurance policies because of your credit score. So if your credit score is on the rise, it could make sense to start shopping for new homeowners, auto and life insurance.

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