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Key Takeaways
ARTICLE | New Federal Rule Proposal Aims To Remove Medical Debt From Credit Scores
A little over a week ago, the Biden administration took a major step toward removing medical debt from credit reports.
According to the most recent data available, as many as 1 in 5 US households carry some amount of medical debt - including a little more than 1 in 10 US households that are covered by private insurance - so the scope of the issue is substantial.
Further, the majority of medical debt is carried by people insured through their employers, and medical debt has been shown not only to affect the mental health and work product of current employees, but it can also shrink the talent pool for prospective hires by making it more difficult for otherwise qualified applicants to obtain work through no fault of their own.
While the reception to the proposed legislation has been largely positive (especially among people with medical debt), other interested parties (especially those benefiting from and tasked with the collection of medical debt) are concerned that the negative unintended consequences may ultimately outweigh the positive outcomes that the new rule is being implemented to achieve.
The rule has to make it through public commentary and post-public-commentary revisions before being enacted and having any real practical impacts, but should the rule ultimately take effect sometime next year, the largest practical impact for affected people (including employees with medical debt) is likely to be improved housing stability.
Proactive employers looking to optimize employee benefits offerings may wish to get ahead of the competition by providing complementary benefits to accompany the newfound borrowing power of affected employees by offering bundled moving service discounts, down payment/deposit assistance programs, and/or relocation bonuses
According to the most recent data from the Kaiser Family Foundation, people in the US owe approximately $220 million in medical debt, with the average US household holding a little less than $5 thousand each.
That average can be a bit misleading, however, given how concentrated much of that debt is among a relatively smaller number of people, with about 14 million people (6% of adults in the US) owing more than $1 thousand dollars in medical debt while about 3 million people (1% of US adults) owing more than $10 thousand.
The distribution of medical debt varies by sex as well, given that about 12.% of women hold medical debt while about 9% of men do.
The CFPB forecasts that the proposed rule will increase the credit scores of people with medical debt by an average of 20 points, which could lead to as many as 22 thousand more people qualifying for mortgages each year.
Some medical debt will nonetheless have an indirect negative effect on credit scores, given that nearly 1 out of 4 people with medical debt has used a credit card to pay for some of all of the amount due for medical services rendered according to a recent study from the Urban Institute, so those charges will still impact credit scores even if/when the new rule is enacted.
Though major strides have been made over the last few years in terms of reducing the number of people negatively impacted by medical debt in credit reporting, this latest development is poised to finish the job and completely decouple healthcare expenses from credit viability assessment.
While more than 100 million people had some amount of medical debt on the books as recently as 2020, data from the CFPB indicates that number has shrunk to as few as 15 million people over the last couple of years as a result of the efforts of state governments, credit ratings agencies, and previous actions taken by federal regulators.
For example, last year the three largest credit reporting agencies announced that they would no longer include certain types of medical debt information in their credit reporting analysis, including bills that had already been paid off in their entirety as well as any debts amounting to less than $500 dollars.
Also, some states have enacted laws that have significantly reduced the number of people with medical debt negatively impacting their credit scores, including Colorado and New York, both of which outlawed taking medical debt into account on credit reports in 2023.
Proponents of the new rule highlight previous research from the CFPB that shows medical debt to be of poor analytical value when it comes to predicting the creditworthiness of a loan applicant in the first place.
That analysis showed that study participants who had medical debt go into collections were significantly more likely to pay back their debts than other debtors with similar credit scores, and that medical debtors were in fact about as likely to repay their debts as people with credit scores that were 16 to 22 points higher.
In effect, banning the use of medical debt when calculating credit scores is not only a step toward fairness, but it will also improve the accuracy and therefore the economic value of those scores overall.Proponents and opponents of the new regulation alike might both point to the analysis done by KFF Health News which indicates that potential damage to debtors’ credit scores is the most prevalent tactic used by medical debt collectors in securing payments.
Opponents, however, would also ask if the most effective debt-collection measure currently available is no longer allowed, how will medical care providers respond? Many may turn to requiring credit cards with sufficient limits on file before rendering services and some may simply require payment in advance of providing service, which has problematic implications for low-income patient equity as well as for emergency care more generally.
Banning the inclusion of medical debt in credit score calculations doesn’t make the underlying debts disappear, and it won’t end the practice of businesses garnishing employee wages on behalf of medical debt collectors, but it will improve the borrowing power of some of the people carrying those debts.
Clearly, the critical levels of medical debt held by people in this country will continue creating issues that go well beyond those associated with negative credit scores, so even if the final rule is ultimately enacted and substantially resembles the proposed one, there are a lot of medical debt-related problems that will go on affecting both employees and their employers just the same.
Still, the importance of the proposed rule shouldn’t be diminished, as there are concrete benefits that can be expected if a comparable final rule is in fact successfully enacted, headlined by strengthened housing stability for medical debt holders, which should be significantly improved given the negative impact that low credit scores can have on both renting and buying property.
But in order to meaningfully address the larger underlying issue of the debt itself, rule makers acknowledged that the proposed rule is just a starting point and explicitly encouraged state and local lawmakers to take further action by buying up and forgiving more existing medical debt and incentivizing greater debt forgiveness (and less aggressive collection efforts/tactics) on the part of local hospitals and providers.
Unless and until there is a major overhaul of the US health system, medical debt is likely to remain a significant issue in this country, and while we remain miles away from resolving the underlying issue, this newly proposed rule from the CFPB is a meaningful step toward removing one of the major accompanying hurdles associated with medical debt, which is an important step to take.
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