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Is This Debt Demon Unknowingly Wrecking Your Credit Score?

There's a word around my household that's even more feared than the "T" word (taxes), and that's the "D" word: debt!

I make it a personal point to pay off my revolving debt accounts each and every month because I don't want to get trapped into the revolving debt cycle like I've seen so many friends and family members get sucked into. While I don't doubt that there are others out there who feel the exact same way, there's one unexpected cost that according to Bloomberg is currently plaguing about one in every four U.S. families. This debt demon is none other than medical costs.

The National Center for Health Statistics at the U.S. Centers for Disease Control and Prevention notes that one in 10 U.S. families had medical costs they couldn't pay at all in 2012. Furthermore, as Bloomberg points out in an interview with Kaiser Family Foundation fellow Karen Pollitz, unpaid medical bills represent the No. 1 reason in this country why families declare personal bankruptcy. Even in families where all members were insured, 21% had some degree of difficulty paying their medical bills.


Source: U.S. Navy, Wikimedia Commons.

The truly terrifying side of this debt demon
But these figures are only the half of it. Unexpected medical needs and the subsequent unpaid medical bills not only exact an undue toll and stress on families, but based on a study (link opens a PDF) from the Consumer Financial Protection Bureau, or CFPB, released just a few days earlier, medical debt also overly penalizes consumers' credit scores.

Based on the CFPB's research of some 5 million anonymized credit reports between September 2011 and September 2013, people with medical debt sent to collections often have their creditworthiness underestimated by up to 10 points, while those who actually manage to repay their medical debt sent to collections may have their creditworthiness underestimated by as much as 22 points. The CFPB's research showed that consumers with medical debt in collections typically paid back their loans on par with someone who had a credit score that was about 10 points higher, while citizens who paid back medical bills that went into collection were more likely to pay back their debts on par with people who had credit scores that were 16-22 points higher.

"Why is this important?" you ask? There are three reasons I can think of why this matters.

Source: Nemo, Pixabay.

First, your credit score is the primary determinant that banks and lending institutions look at when considering what interest rate you'll pay on a loan, or in some cases if you even can qualify for a loan. The gap between 10 and 22 points can sometimes make the difference between being considered creditworthy and being unable to receive a loan, or getting a loan with a significantly higher interest rate. This can essentially limit the number of people who can buy a home or purchase a car, for example.

Second, one of the primary points of the CFPB report is that credit bureaus aren't properly distinguishing between medical and non-medical debt. While all debt might appear equal, the CFPB study demonstrates that people who've unfortunately been burdened with extensive medical costs are generally more creditworthy than their scores would appear.

Finally, medical costs that have gone into collections can sometimes go unnoticed by citizens. The CFPB notes that most medical debt is reported by third-party agencies, and that slip-ups in reporting that eventually lead a debt to go into collections aren't uncommon. This is bad news for consumers, since medical debt that's gone into collections can stay on someone's credit report for up to seven years. 

How you can fight back against unexpected medical costs
The light at the end of the tunnel, if there is one, is that there are steps you can take to prevent medical costs from destroying your credit score. In general, it just means you have to be extra vigilant should you need to receive unexpected medical care.

Source: StockMonkeys.com, Flickr.

The first step anyone should take that's received a medical bill is to review it in its entirety for correctness. This involves going beyond simply noting whether the right procedures are on the bill, and digging into the intricacies of whether or not you were charged for a full day's stay if you were discharged in the morning, or if you were charged for medication that you brought from home. These mundane details can add up quickly, so taking the time to understand the source of each charge is your important first step.

Second, consider talking directly with the hospital or medical clinic to set up a payment plan if you can't afford the upfront out-of-pocket payments. There's nothing worse for a hospital than collecting no money whatsoever and having to turn the uncollected debt over to a collection agency. Instead, you'll find that most hospitals are often more than willing to work with a patient to set up a payment plan over time. Along these same lines, you may also have the ability to bargain down the amount you owe based on what you can afford in out-of-pocket costs.

Third, and this should be something most everyone considers because there are considerably worse things in this world than being told "No," you should consider applying for financial assistance with the hospital or medical facility you received treatment from. Financial assistance is no guarantee, and you'll be required to apply for Medicaid before taking this course, but if it the bill is eventually reduced to zero it could be well worth it!

Fourth, as Forbes notes, you can always turn to a medical-billing advocate that deals with these cases on a regular basis. As long as you find one that doesn't require upfront fees to get started and caps its charges, this could very well be worth your while.

Lastly, you can consider turning to crowdfunding websites as an option to help pay some or all of your medical bills. In August of last year Forbes listed Kickstarter, Indiegogo, RocketHub, FundRazr, GoGetFunding, Crowdfunder, and StartSomeGood as some of the top crowdfunding websites. For a nominal collection fee you can tell your story and hope that philanthropic donors help support your cause.

Ultimately, medical costs are never welcome, but they don't have to be the destroyer of your credit score if you know what to look for and how to fight back.

In addition to saving protecting your credit score, taking advantage of this little-known tax "loophole" could set you up for a comfortable retirement
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Sean Williams
TMFUltraLong

A Fool since 2010, and a graduate from UC San Diego with a B.A. in Economics, Sean specializes in the health care sector, but also has a penchant for mining, retail, and automotive stocks, as well as personal finance and macroeconomic topics of interest.

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