Paying Off Collections to Improve Your Credit Score
You want to improve your credit scores, but you have outstanding debts to a collection agency. Before you pay it all off, take a few moments to evaluate your personal situation. Different types of debts should be handled in different ways because they each impact your credit scores uniquely.
The way you handle your repayment also depends on how old the debt is, so pay attention to the details to make sure you make the right decisions. Get ready to learn the nitty-gritty of paying off your collection accounts so you can get on the path to a better credit score.
The Difference Between Collections and Delinquent Debts
Before you start creating a debt repayment strategy, it's important to understand the differences between the types of debt. A delinquent debt is technically any debt with an outstanding payment.
But most creditors, especially credit card companies, don't report delinquent payments to the credit bureaus until the account is at least 30 days past due. From there, the delinquency is updated in 30-day increments: 60 days, 90 days, and 120 days.
Each level has an increasingly negative effect on your credit scores and can actually lower by as much as 125 points. Even if you pay off the balance owed, that late payment remains as a derogatory item on your credit report for a full seven years.
Once your delinquent payment reaches a certain point, the creditor will most likely sell it to a collection agency to take over the management of your account. At that point, you'll likely receive more aggressive contact from the debt collector as they attempt to recuperate the money owed.
There's no set time frame as to when an account is sent to collections, but many credit card companies do so after a payment is 180 days late.
You'll receive a notice that this is happening so you know exactly where your debt stands. Your credit scores will also be updated to reflect the transfer of your debt to a collection agency, which will further hurt your credit scores.
How Delinquencies and Collections Affect Your Credit Score
Unfortunately, there is no cut and dry explanation on how delinquent accounts and collection accounts affect your credit score. Part of the reason is that there are different credit scoring models that each weigh these items differently.
The two most popular scoring models, the FICO score and VantageScore, both have older and newer versions that incorporate different calculations.
The most recent versions, FICO 9 and VantageScore 3.0 don't even consider collections that are paid off when calculating your credit score. They also weigh medical collections less heavily than other types of debt.
However, the problem is that older versions of credit scoring models don't expire and it takes time for lenders throughout the country to update to the newest versions. That means your credit scores could vary greatly depending on what lender you decide to work with and what scoring model they currently use.
When to Pay Off Collections and Other Negative Accounts
A good rule of thumb to start off with when creating a payoff strategy for your debt is to tackle the most recent delinquencies first. That's because even though negative accounts don't drop off your credit report until seven years later, their effects on your credit scores lessen over time.
By paying off the newest collection accounts first, you'll remove the most damaging items on your credit report which should improve your overall credit score.
If all of your collections are roughly the same age, you could consider negotiating a settlement and paying off the lowest amounts first.
Settling a debt refers to paying less than what you owe while still having the creditor mark the account as paid. In fact, paying a debt in full has the same effect on your credit scores as settling your accounts. So, it's worth trying to negotiate a settlement to save some money.
If you do settle and pay a lower amount, the newer credit scoring models for both FICO and VantageScore count it just as favorably as if you had paid off the full amount.
Another tip is to ask the collection agency to remove the negative item from your credit report altogether as part of the settlement. Make sure to get a copy of the full agreement in writing, so there are no discrepancies later on.
Paying Taxes on Forgiven Debt
Also note that unless you qualify for an exemption, you'll probably have to report your canceled debts from a settlement as part of your income when it comes time to file taxes. That could quickly add up to a lot of money depending on how much you owe and might even bump you up into a higher tax bracket.
It's often wise to consult a financial advisor before making any major decision to ensure you understand the full weight of your choice. Otherwise, you might end up owing Uncle Sam much more than you'd like to — and he doesn't let you skip out on payments!
After paying off collections, you'll probably be excited to see how high your credit score has risen. But be sure to remember that just how much that needle moves (and in what direction) depends on which credit scoring model is used to calculate your credit score.
You might notice a change of just a few points, or you might happily see it jump close to triple digits. Either way, you'll definitely start to notice an increase over the long-term, regardless of which scoring model is used.
Handling Negative Items Older Than Seven Years
Negative items, including those sent to collections, automatically roll off your credit report after seven years, whether you've paid them or not. You might think you're in the clear and don't have to worry about those debts anymore, but that isn't always the case.
There are a few different reasons why you might want to pay off old debts even when they're no longer listed on your credit report. One reason is that in the event the original debt collector sells your debt to another debt collector, the account can be reopened for an additional seven years.
The new collection agency might be more aggressive with its tactics and could even threaten to sue you for the amount owed. It's usually best to avoid a lawsuit. If you find yourself in this situation, you may want to consider agreeing to a settlement with the collection agency.
However, there are a few intricacies to be aware of when deciding how to handle a delinquent debt that is beyond seven years old. Once you make a payment or perform any other activity on the collection account, it could be reactivated and reappear on your credit report.
Depending on the state in which you live, making a partial payment could also reset the time limit on the statute of limitations. That opens you back up to the potential of lawsuits from collectors. Consider all the potential repercussions before you decide which accounts to pay off and when.
Dealing with Other Types of Late Payments
In addition to delinquent debts that have been sent to collections, you might simply be late on your payment of any other kind of bill, whether it be a credit card, a mortgage, or a car loan.
You won't see a huge jump in your credit score just because you get up-to-date on these accounts, but you will have decreased your amounts owed.
While that's certainly a good perk, simple late payments also stay on your credit report for seven years just as collections accounts do.
However, if your late payment was a one-time occurrence, you can try sending the creditor a goodwill letter to ask them to remove the item from your credit report. Give a reason as to why you were under economic hardship and how you've otherwise been a good customer.
Even if sending a goodwill letter doesn't work or doesn't apply to your situation, you can begin to rebuild your credit score today by building a strong financial foundation. That means making all of your payments on time and in full as you move forward.
This method requires a little more patience but it's extremely effective and something that any lender or other creditor wants to see on your credit report when applying for a loan or a credit card.
Combine this positive habit with keeping your debt low and you'll set yourself up for better credit scores in no time at all.
