Credit Scoring Model Bucks the Industry Line on Paid Debts

When unpaid bills go to collections agencies, the consumers' credit scores often suffer long after they pay off the debts.

The practice of penalizing consumers' scores for paid collection accounts has sparked howls of protest — particularly in the baffling realm of medical billing, where patients routinely haggle with health insurance providers over responsibility for payment.

Complaints about the practice have raised the threat that Congress might impose new rules. But now it looks at least possible that the private sector will be able to resolve the issue on its own.

VantageScore Solutions, which competes with Fair Isaac Corp. in selling credit scores to some of the nation's largest lenders, tells American Banker it has removed paid collection accounts from its latest credit scoring model. The company is believed to be the first in the industry to make the change.

VantageScore says cold, hard numbers motivated it to make the change. The company was trying to build a model that offered the best possible predictions of consumer behavior, and its mathematicians determined paid collections accounts are a poor predictor of default.

"At the end of the day, the mathematics had to win out from an objective standpoint, and not from a subjective standpoint," says VantageScore President and Chief Executive Officer Barrett Burns, though he is well aware of the controversy over counting unpaid collection accounts.

Sarah Davies, VantageScore's senior vice president for analytics, says she compared the risk profile of consumers with paid and unpaid collection accounts. "The risk associated with the unpaid was much, much higher," she says.

The move by VantageScore bucks the position staked out by the Consumer Data Industry Association, a trade group for credit reporting agencies. "Broadly speaking, a precedent of deleting adverse information once a delinquent debt is paid would seriously impinge on the quality of data," a spokesman for the organization told The New York Times last year.

The association sounded more flexible in an email to American Banker. A spokesman for the group stated that objective credit report data should be available to lenders, but added: "As the lender reviews its loan portfolio periodically, it might adjust the weights for certain factors or discount those factors entirely based on its loss experience." (Fair Isaac, the leading score provider, says the damage to a consumer's score from a collections account varies depending on factors such as whether other negative information is on file.)

Most of the consumer complaints regarding the use of paid collections data have focused on the medical sector.

Legislation that passed the House in 2010, but has stalled since then, would bar credit agencies from using paid-off medical debt in assessing a consumer's creditworthiness. That legislation has drawn support from consumer groups and industry organizations such as the Mortgage Bankers Association.

The move by VantageScore is arguably more sweeping than the legislation, because it dispenses with considering any paid collections accounts, medical or otherwise. And VantageScore's model will treat debt as having been paid off in instances where the debt is settled for less than the amount initially charged, according to the credit scoring company.

A congressional aide who supports the legislation calls VantageScore's announcement encouraging.

"Taking them at their word, it sounds to me like they've decided that the bill makes a lot of sense, and they're just going to do it," the staffer says.

Chi Chi Wu, an attorney with the National Consumer Law Center, expresses more skepticism about the likely impact of the change.

That's partly because paid collection accounts will remain on consumers' credit reports, even if they are not used in the calculation of a credit score. "Employers will use credit reports" in evaluating job candidates, Wu notes.

The new model, VantageScore 3.0, is scheduled to be unveiled Monday at the Consumer Bankers Association's annual conference in Phoenix. It is unclear how many lenders will choose to adopt the model, and whether it will establish a new standard in the marketplace.

Scores from VantageScore — which is jointly owned by the three major credit reporting agencies, Equifax, Experian and TransUnion — are far less widely used than those from FICO, according to a 2011 report by the Consumer Financial Protection Bureau.

The credit reporting agencies have come under recent fire regarding the difficulties consumers often have in getting corrections to errors in their credit reports.

VantageScore, based in Stamford, Conn., appears to be betting that offering a consumer-friendly face will be a selling point to the lenders that purchase credit scores.

In addition to VantageScore's decision to stop considering paid collections accounts, the company's new model includes a new feature that will benefit victims of natural disasters.

And the firm is launching a consumer website, ReasonCode.org, which will provide more detailed explanations of the two-character codes that are used to notify consumers as to why their credit scores are not higher.

"We're all about the consumer. We're all about education," says Burns, the company's CEO.

For many lenders, the bottom line is likely to be: how many people does the company's new model score, and how good is it at predicting which borrowers will default?

VantageScore's new model will be able to provide scores for 13 million more consumers than its previous version did, according to the company.

The company claims its new model is up to 25% more predictive than earlier models, based on an analysis of consumers' credit files over a two-year period.

For the previous version of the VantageScore model, the company analyzed 500 borrower characteristics, which it winnowed to about 110 traits that went into the model, officials say. When building the new version, the firm looked at 900 characteristics and ultimately used 150 of them.