Healthcare FSA: A Bad Credit Medical Financing Alternative

Patients with bad credit histories and low scores face four critical problems when they try to finance a medical procedure.

  1. Finance companies often reject applicants with bad credit, so approvals are rare.
  2. Approved patients face high costs and short pay-back times, which means higher monthly payments.
  3. Lenders often approve loans that are too small to cover patient needs
  4. Patients who can’t pay the new loan can face serious consequences.

A Healthcare Flexible Spending Account (HCFSA) offers a better alternative for many people. It has high approval rates, no borrowing costs, and no penalties for missed payments.

Availability Disclaimer

A Healthcare Flexible Spending Account (HCFSA) often beats medical financing but has a significant downside. Only some employers offer this program, leaving out the self-employed, 1099 contractors, small business workers, and others.

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A personal loan may be the best option for patients without access to an HCFSA at work. Be prepared with employment and banking details to boost approval odds.  

HCFSA Loan Attributes

A Healthcare Flexible Spending Account (HCFSA) is not a medical financing program, but it allows employees with bad credit to get treatment now and pay later. An HCFSA has attributes of a loan or credit card without being one.

Transfer Of Money

An HCFSA allows one party to transfer money to another, similar to how a medical loan works. Employers directly pay healthcare providers for qualified expenses.

Employees can access all of their annual HCFSA funds at the beginning of the plan year. The IRS uniform coverage rule requires immediate access to HCFSA funds. This rule also bans speeding up an employee’s contributions through salary reduction.

Employees can directly pay providers for healthcare, vision, and dental services using a debit card. Employers pay providers before employees contribute to the account.

Repayment Agreement

An HCFSA’s repayment agreement resembles that of a medical loan. According to IRS rules, an employee’s choice of contribution during open enrollment is final. It can only change if the employee experiences a qualifying life event, like a divorce or the death of a spouse.

However, qualifying life events do not allow employees to adjust annual elections below the amounts already reimbursed by employers. Therefore, repayment is assured as long as the employment relationship continues.

Employees make fixed contributions from their pay each period during the HCFSA plan year. The employer’s pay schedule sets how much of the annual contribution is taken out each time. For example:

  • Every week: 1/52 of the annual amount
  • Every two weeks: 1/26 of the annual amount
  • Every month: 1/12 of the annual amount

When HCFSA Beats Financing

An HCFSA works better than medical financing for several reasons. Employees with bad credit using an HCFSA can expect more approvals, lower costs, smaller monthly payments, more credit, and fewer consequences when missing payments.

Credit Qualifications

It is much easier for patients with bad credit to qualify for a Healthcare Flexible Spending Account (HCFSA) than medical financing.

  • Private lenders frequently reject applicants with poor borrowing credentials.
  • Employers generally allow most employees to participate in an HCFSA.

HCFSA Qualifications

Most employees with bad credit can use HCFSA funds to pay for medical treatment upfront. Employers cannot review credit reports or deny employees with low credit scores due to financial issues like bankruptcy or foreclosure.

IRS rules prevent HCFSA plans from favoring high-earning employees. Non-discrimination testing takes into account income, not credit reports or scores.

Financing Qualifications

Patients with bad credit seeking medical financing from private companies face high rejection rates. Most lenders check credit reports and scores, often denying applicants with issues like bankruptcies, charge-offs, repossessions, or foreclosures.

Private lenders sometimes provide medical loans without credit checks to people with little or no credit history rather than those with poor credit records. These lenders often rely on non-traditional credit bureaus that report on rent and utility bill payments.

Borrowing Costs

Employees with bad credit do not incur borrowing costs using a Healthcare Flexible Spending Account (HCFSA) instead of a medical financing program. Additionally, participants lower their taxable income and save money by contributing to an HCFSA with pre-tax dollars.

HCFSA Cost Savings  

Employers cannot charge interest or impose origination fees. Employees can use an HCFSA instead of a medical loan for a scheduled procedure without incurring any borrowing costs.

Employees can reduce their tax burden using an HCFSA, resulting in net savings—pre-tax contributions to an HCFSA lower the taxable income.

For example, by contributing to an HCFSA, a married couple in California with a $100,000 adjusted gross income could save 38.95% by avoiding these three taxes:

  1. Federal income tax: 22%
  2. California income tax: 9.3%
  3. FICA payroll tax: 7.65%

Higher Financing Costs

Private finance companies impose higher interest rates and origination fees on medical patients with bad credit due to the increased risk of default. Lenders charge more to offset the higher risk of default by these borrowers.

  • High interest rates, which can reach up to 30%, affect long-term loans more as the interest accumulates over a longer period.
  • Short-term loans are particularly impacted by high origination fees, which can be as much as 10% of the loan amount.

While medical expenses paid with loan proceeds are tax-deductible, the lender’s interest and origination fees are not.

Monthly Payments

An HCFSA often offers more affordable monthly payments than medical financing, allowing for a consistent repayment period not influenced by an employee’s credit status.

While borrowing costs and tax savings play an essential role in affordability, the repayment period is the primary factor determining the size of each installment.

This chart illustrates how the repayment period influences the size of periodic principal-only installments. Borrowing costs and tax savings are not included.

Repayment Term$3,000 Owed$6,000 Owed
3 Months$1,000$2,000
6 Months$500$1,000
12 Months$250$500
24 Months$125$250

Lower HCFSA Payments

With an HCFSA, employees can spread the repayment of an upfront-funded medical expense over twelve months. They can also schedule procedures early in the plan year to fully utilize the repayment period, extending the time available for repayment.

We present the principal-only chart again while highlighting the twelve-month row to illustrate the lower monthly payments.

Repayment Term$3,000 Owed$6,000 Owed
3 Months$1,000$2,000
6 Months$500$1,000
12 Months$250$500
24 Months$125$250

Higher Financing Payments

Private lenders often restrict the repayment period for medical financing for customers with bad credit due to the higher risk of default associated with longer terms. For lenders, short-term loans are considered safer because they minimize exposure to the uncertainties of a borrower’s future financial situation.

Borrowers with limited credit options may only secure loans with three or six-month repayment periods, which leads to higher monthly installments due to the condensed timeframe.

We present the principal-only chart again while highlighting the three-month row to illustrate the higher monthly payments.

Repayment Term$3,000 Owed$6,000 Owed
3 Months$1,000$2,000
6 Months$500$1,000
12 Months$250$500
24 Months$125$250

Funding Limits

An HCFSA has annual contribution limits. However, patients with bad credit histories often find securing large enough loans from medical financing programs difficult.

HCFSA Limits

Employees can pay for approved medical care with the amount they put into their HCFSA during open enrollment. The IRS sets these limits, which rise yearly to keep up with inflation.

The current HCFSA limit is $3,200, but a married couple with two plans can contribute $6,400.

For instance, our married couple in California might choose a $6,400 contribution together during open enrollment. Their employers could then pay this total amount for a medical bill early in the next plan year.

Financing Limits

Patients with bad credit rarely qualify to borrow significant sums through medical financing programs. Lenders might approve smaller loans that fit the borrower’s ability to pay. They use the debt-to-income ratio, or DTI, to make this call.

The DTI ratio is calculated by dividing total monthly debt payments by monthly income. A good DTI ratio is 36% or less, which takes into account all these types of payments:

  • Mortgage principal, interest, insurance, and property taxes
  • Rent for an apartment
  • Installment loans
  • Revolving debts like credit cards or lines of credit
  • Student loans
  • Alimony and child support

Default Consequences

People with poor credit using an HCFSA face no risk of defaulting. In contrast, those with medical loans may face severe consequences for missed payments, such as legal action and tarnished borrowing credentials.

HCFSA Consequences

Employees cannot fall behind on HCFSA payments while working because their employer automatically takes pre-tax money from their paychecks.

Employees on unpaid FMLA leave can stop their HCFSA contributions by canceling their enrollment. This action means they won’t owe money for any medical expenses already paid for by the HCFSA.

Employees do not have to pay back any HCFSA upfront funding after job termination. It does not matter whether they quit, retired, got fired, or their company laid them off. 

Employers cannot file lawsuits to garnish wages or place liens on property.

Financing Consequences

Patients with bad credit are more likely to default on medical financing obligations and experience severe consequences when they do. Defaulting can lengthen the period that negative payment records appear on their credit reports and may lead to legal action.

Most finance companies report payment history to credit bureaus. Negative items disappear from reports seven years after the first delinquency. Therefore, new negative marks on a credit report can prolong the period when securing loans is most challenging.

After loan defaults, lenders often sue to recover their money. If the court rules in their favor, they can garnish your wages or put a lien on your property, like your house or car.

When Financing Beats HCFSA

A Healthcare Flexible Spending Account (HCFSA) may not always benefit employees with poor credit. Medical financing may be more favorable than an HCFSA in specific instances related to timing and procedure reasons.

Eligible Procedures

Many procedures are HCFSA eligible, while others are not. Medical financing programs work better for cosmetic treatments. Patients with poor credit may find medical financing their best option.

Necessary Procedures

An HCFSA works best when a procedure is medically necessary; it treats an illness, injury, or symptoms. In these cases, the plan administrator should approve most claims.

Getting a pre-approval eliminates doubt for marginal cases. Advance submission documenting medical necessity could make an enormous difference when treatment falls into a gray area, as with these examples.

Cosmetic Procedures 

Medical financing programs are best for cosmetic procedures that reshape healthy tissue to improve appearance, symmetry, and other aesthetics. An HCFSA does not cover cosmetic treatments and is not an option.

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A personal loan is an excellent way to pay for cosmetic procedures that an HCFSA will not cover, such as liposuction, Brazilian butt lifts, breast enhancement, hair transplants, and many others.

Funding Timing

The timing of procedures impacts the HCFSA versus medical financing debate. Patients with bad credit have limited options to fund emergency treatment, while they have a clear choice with elective surgeries.

FSA Elective Procedures

An HCFSA works best with elective medical procedures because employees can schedule the surgery or treatment at the beginning of the plan year. Employees can make the appropriate contribution choice during the preceding open enrollment.

Employees have twelve months to repay the advance, making the periodic payments predictable and affordable. Below is a partial list of elective procedures that work well.

Financing Emergency Procedures

Patients might need funds quickly for emergency procedures, making medical financing a better option than an HCFSA. Urgent health issues need immediate attention. Waiting until the annual open enrollment to elect an HCFSA contribution does not work.

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Many have health plans with high deductibles. They might need loans for unexpected bills from emergencies like heart attacks or accidents.