A triple play will soon hit the credit scores of millions of Americans — medical debt, college loans, and to a lesser extent buy-now-pay-later plans will all be reflected in credit reports.
Credit scores could end up being 20 or more points lower, according to financial experts, making it more difficult to finance mortgages, car loans, and apply for credit cards at a time when the U.S. economy is already showing signs of slowing.
“There are 45 million people with student loan debt and 15 million with medical debt. It’s highly likely that there is some overlap there,” said Adam Rust, director of financial services for the Consumer Federation of America. “People are really facing a perfect storm here.”
On July 11, U.S. District Court Judge Sean Jordan of Texas — appointed by President Donald Trump — vacated one of President Joe Biden’s last acts, a rule put in place by the Consumer Financial Protection Bureau (CFPB) in January that would have removed medical debt from credit reports. The Consumer Data Industry Association and the Cornerstone Credit Union League challenged its validity, and the court sided with the industry groups, determining that the rule exceeded the CFPB’s authority under the Fair Credit Reporting Act, which protects information collected by consumer reporting agencies.
Although the three national credit reporting agencies — Experian, Equifax and TransUnion — announced last year that they would remove medical collections under $500 from consumer credit reports, the CFPB rule would have removed roughly $49 billion in medical bills from the credit reports of an estimated 15 million Americans. The Bureau estimated that, as a result, the credit scores of people burdened by medical debt would have increased by about 20 points, and that in turn would have helped get about 22,000 additional mortgages approved every year, the CFPB said.
The medical debt change comes just two months after a decision in May by the Department of Education to restart collection of college loans, suspended during the pandemic. Federal student loan debt now tops $1.6 trillion, spread across more than 43 million borrowers. Borrowers who fail to resume payments could face seized tax refunds and wage garnishment.
Of the two types of debt, it is college loans that will likely have the greater impact, and cause real chaos for consumers, said Kevin King, vice president of credit risk for LexisNexis Risk Solutions. Many banks exclude medical debt from their credit worthiness formulas because “to punish a consumer for struggling to meet a financial obligation that they didn’t sign up is pretty difficult to justify,” he said. “College loan delinquencies are harder to dismiss,” even though many borrowers had delayed payments over the last few years because of constantly changing rules on repayment.
As of April, 31% of federal student loan borrowers are 90 days or more past due, according to TransUnion. Close to 2 million of those borrowers are expected to hit default status this month, and another 3 million people are on track to default by September. More than two million borrowers have already experienced credit score declines of at least 100 points, a New York Federal Reserve report said. On average, delinquent borrowers have lost about 60 points from their credit scores.
Then in June, the major credit reporting firm FICO announced that, starting this September, it will incorporate “buy now, pay later” (BNPL) loan data into its scoring models. Payments for these plans are not typically reported to credit bureaus, so missing one does not impact credit worthiness, and industry experts do not expect the change to have a significant impact on consumer credit scores in the short term. However, their popularity has skyrocketed since the pandemic.
A CFPB Market Report found that the number of such loans in the United States grew more than tenfold from 16.8 million to 180 million from 2019 to 2021. In terms of the dollar volume, it went from $2 billion to $24.2 billion. And a Lending Tree report issued this month found that more than four in ten BNPL borrowers have late payments, up from 34% from the previous year, and 25% of consumers who rely on such services use them for everyday goods like groceries, up from 14% one year ago.
“Buy Now, Pay Later loans are playing an increasingly important role in consumers’ financial lives,” said Julie May, vice president and general manager of B2B Scores at FICO, in a press release. By including these loans, “we’re enabling lenders to more accurately evaluate credit readiness, especially for consumers whose first credit experience is through BNPL products.”
All these changes put lower-income consumers in a difficult position as they struggle with what is known in the credit industry as the “hierarchy of payments—i.e., which bill do I pay first? “But at the end of the day,” says LexisNexis’ King. “There are going to be fewer consumers who meet FICO scores for loans,” and that, he warned, could have a ripple effect on the economy.