Tuesday, June 24, 2014

Will Settling With a Collection Agency Improve My Credit Scores?

If you have debts in collections, sooner or later settling with the collection agency will be an option. Collectors don't generally offer settlements up front but after realizing that you're not going to pony up the full
Settling collections? Be careful.
amount, most would rather settle with you and get a portion of the debt you owe than nothing at all. Unfortunately, settling debts only benefits the collection agency and, in some circumstances, can be a devastating financial decision that you'll live to regret.

Settling with a Collection Agency Doesn't Improve Your Credit

The most important fact you should know about settlements is this: settling a debt with a collection agency doesn't improve your credit scores. Debt collection letters almost inevitably include the statement that "Your credit report will be updated accordingly." Consumers often mistakenly translate this to mean that making settlement arrangements will lessen the negative impact a collection account has on your credit score--and this simply isn't true.

I've said it before and I'll say it again: paying collections doesn't improve your credit scores. Federal law requires collection agencies to report accurate information to the credit bureaus, but a collection account is always going to be negative. The account's payment status--paid, settled, etc--doesn't affect this at all. You could pay the entire collection in full and, unless the collection agency agrees to remove it from your credit report, doing so won't improve your credit scores.

Settling Collection Debt May Restart the Statute of Limitations

State laws concerning the statute of limitations for debt collection lawsuits vary, but in most states making a payment on the debt is enough to restart the statute of limitations from day one--even if its already expired. This is very beneficial to collection agencies. As soon as you make the first payment on your settlement agreement, the collection agency can file a lawsuit against you for the full remaining balance. Now, if you have a settlement contract with the collector that spells out the terms of the agreement in writing, it may provide you with protection against such a lawsuit. Most debtors who opt to settle, however, never request a formal settlement agreement. They simply make arrangements over the phone and begin making payments--leaving themselves vulnerable for a terrible bait-and-switch.

Collection Agency May Sell the Unpaid Settlement Balance to Another Collector

I've discussed this before, but it bears mentioning here as well. Without a written settlement agreement stating otherwise, a collection agency can increase the amount it collects on your debt by accepting your settlement payment and then selling your account to another collection agency.

What makes this so insidious is that the new collection agency immediately gets to work collecting the unpaid portion of your debt. After all, you didn't settle the debt with them. You settled with the debt's previous owner, and your pleas of "but I already paid this!" will fall on deaf ears.

Settling Collections Could Lower Your Credit Score 

A new collection will hurt your credit rating
To make matters worse, the new collection agency may report the debt to the credit bureaus. Although consumer protection regulations do not allow the credit bureaus to report two collections on your credit report for the same debt, it happens all the time. All the new collector has to do is assign the debt a new account number. The amount reported will differ because you paid part of it in your original settlement. You can fight a duplicate collection and eventually have it removed, but doing so is a headache you don't need. And in the meantime, your credit scores suffer.

Get a Written Settlement Agreement to Protect Yourself

Settling isn't always a bad deal. Although it doesn't help your credit, if you negotiate properly, you could end up with the collection agency off your back. That in itself is worth it for some harried debtors. If you're considering a settlement, its always a good idea to get the terms of the agreement in writing from the collection agency before you start making payments. In order to protect yourself, your agreement should contain the following provisions:

  • The collection agency agrees not to take legal action against you during the course of paying off your settlement. 
  • The collection agency agrees not to sell the unpaid portion of your debt to another collector after you've paid the settlement amount
  • The collection agency agrees to consider the debt paid and not attempt to collect the unpaid balance after you finish paying off your settlement (you wouldn't believe how often collectors suddenly "forget" that you had a settlement agreement in the first place). 
  • If possible, get the collection agency to update your credit report to reflect that the debt has been "paid" rather than "settled." Your credit scores remain unaffected but a paid debt looks better to future lenders than a settled one. 
There is one way that settling a collection account can improve your credit. If the collection agency agrees to delete its tradeline from your credit report in return for payment, your credit scores will improve. This is known as a "pay for delete." Pay for deletes aren't common because they are frowned upon by the credit bureaus. You're also a lot more likely to get one if you pay the debt in full or settle in one lump sum (debt collectors have quotas to meet, after all) but if you're successful, this is the only way that settling with a collection agency will improve your credit scores. 

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  1. I have a question. I got a Target CC last year, used the paper temporary one for 2-3 days, while using a regular CC for other Target purchases. I later got the real card and decided I didn't want to use it, so it sat in a drawer for a year. I had assumed my husband paid whatever bill came in (he does all the paper bills, I do online payments) and and I missed that he never said anything about Target. Long story short, we never got a bill from them, or notice, calls, anything.

    This week, I learned that they charged off the bill in December (was $289, now $489 with late fees) and when I checked my credit report, it had taken a huge hit. I called ARM, told them the above, and faxed them a letter to verify this. Tomorrow I'll send certified letters to them and dispute letters to the credit reporting companies. Everything else is showing as paid on time but this.Is there any point in contacting Target? Or any other suggestions?

    1. There is absolutely a point in contacting Target because the exact same thing happened to my wife a few years ago with an Old Navy card. I handle the bills, never noticed the lack of a bill and bad things happened. We contacted Old Navy, explained what had happened and as it turns out they had the wrong address on file (which is probably what's going on with you). Long story short, Target has the power to pull your account out of collections, re-age it (the good re-aging, not the bad kind that collectors do) and let you pay it. It helps if you can pay it all in one lump sum. If they're nice about their error, they'll even remove the late fees. So yes, call Target!