How Medical Debt Affects Your Credit Score

How Medical Debt Differs from Other Debts

Medical debt works differently than other types of debt like credit cards or auto loans. Most medical providers don’t report unpaid bills directly to credit bureaus. Instead, they may sell the debt to collection agencies after a certain period. Once in collections, the debt can appear on your credit report, damaging your score.

Medical debt is often treated more leniently than other debts by lenders. However, it can still lower your credit score, especially if it reaches the collections stage.

The Impact on Your Credit Score

Unpaid medical bills can have a negative effect on your credit score. Once a debt enters collections, it stays on your credit report for up to seven years. However, newer credit scoring models give less weight to medical debt than to other types of collections.

For example, FICO and VantageScore models often exclude paid-off medical collections. But, if your score is based on an older model, unpaid medical debt can lower your score by dozens of points. The lower your score, the harder it becomes to qualify for a mortgage or get good terms.

Effects of Medical Debt on the Mortgage Approval Process

How Mortgage Lenders View Medical Debt

When you apply for a mortgage, lenders evaluate your overall financial health. While medical debt is often seen as less risky than credit card or personal loan debt, it still influences the lender’s decision. If your medical debt has reached collections and shows up on your credit report, it can raise concerns for lenders.

Lenders want to ensure you can handle your mortgage payments without being overwhelmed by existing debts. Even if medical debt is viewed more leniently, it can still affect your ability to get a mortgage, especially if it significantly impacts your credit score.

The Debt-to-Income (DTI) Ratio and Medical Debt

One key factor lenders consider is your debt-to-income (DTI) ratio. This ratio compares your monthly debt payments to your monthly income. A high DTI ratio indicates you may struggle to manage additional debt, including a mortgage.

Even though medical debt may not count as a traditional monthly payment, it still influences your overall financial profile. If you’re making payments on medical bills or have outstanding balances in collections, it increases your total debt burden. A higher DTI ratio could reduce your chances of mortgage approval or lead to less favorable loan terms.

Credit Score Thresholds for Different Mortgage Types

Different mortgage types have varying credit score requirements. For example:

  • Conventional Loans: Typically require a credit score of at least 620.
  • FHA Loans: These government-backed loans may be available with a credit score as low as 580, but you might need to make a larger down payment.
  • VA Loans: Available to veterans, these loans usually require a credit score of 620 or higher.

Medical debt in collections can significantly lower your credit score, making it harder to meet these minimum requirements. For example, a drop of 50-100 points due to medical debt could push you from qualifying for a conventional loan to needing an FHA loan with a higher down payment.

Effect on Loan Terms

Even if you’re approved for a mortgage, having medical debt can affect your loan terms. Lenders may offer a higher interest rate or require a larger down payment. A lower credit score signals a higher risk to lenders, and they may compensate by adjusting the terms of your loan. This could result in you paying thousands of dollars more over the life of the mortgage.

Mitigating Medical Debt’s Effects on Your Credit and Mortgage Eligibility

Strategies to Minimize the Impact of Medical Debt

If medical debt is affecting your credit score or mortgage eligibility, there are steps you can take to reduce its impact:

  • Negotiate Medical Debt: Before medical bills go to collections, try negotiating with your healthcare provider or hospital. Many institutions offer payment plans or reduced rates for patients who face financial difficulties. Avoiding collections will help protect your credit score.
  • Pay Off or Settle Medical Debt: If your medical debt is already in collections, paying it off can help. Newer credit scoring models like FICO 9 and VantageScore 4.0 ignore paid-off medical collections. Settling for a lower amount with the collections agency can also reduce the financial burden, even if it doesn’t fully remove the debt from your credit report.
  • Check for Errors: Medical debt is often riddled with errors, such as incorrect charges or duplicate billing. Regularly review your medical bills and credit report for mistakes. If you find any, dispute them with the credit bureaus to have them removed from your record.
  • Utilize Medical Debt Forgiveness Programs: Some nonprofit organizations, state programs, and hospitals offer debt forgiveness for patients in need. These programs can eliminate part or all of your medical debt, improving your financial situation and increasing your chances of mortgage approval.

Recent Policy Changes Regarding Medical Debt

In recent years, there have been changes in how credit bureaus handle medical debt, which can benefit you when applying for a mortgage:

  • Removal of Paid Medical Debt from Credit Reports: Paid medical collections no longer appear on credit reports, thanks to changes implemented by major credit bureaus. If you’ve settled or paid off your medical debt, it won’t harm your credit score.
  • One-Year Grace Period Before Reporting Medical Debt: Medical debt won’t be reported to credit bureaus for one year after the date of service. This grace period allows time for disputes or negotiations before the debt impacts your credit.
  • Increased Focus on Large Debts: Starting in 2023, credit bureaus will no longer include medical debt under $500 on credit reports. This shift benefits many people by removing smaller bills from their financial profiles.

These changes provide breathing room and help mitigate the negative effects of medical debt on your credit score, making it easier to qualify for a mortgage.