Why Paying Off Collections Doesn't Improve Your Credit Score

Debtors are often shocked to learn that paying off collections doesn't improve credit scores. Your credit

report will reflect the payment, but a collection is always a negative entry regardless of how much--if any--of the debt you've paid off. Understanding how the credit scoring system works is crucial to understanding why paid collections are just as bad as unpaid collections.

Credit Scoring and Why Paying Off Collections Doesn't Matter

The FICO scoring system--the most widely used by lenders in this country--exists solely to help lenders evaluate an applicant's level of risk. Can you imagine how much money banks and credit card companies would lose if there was no credit scoring system in place? Every single time they wrote a loan or extended credit to an individual they'd be playing financial Russian roulette. The FICO credit scoring system was born to help lenders maximize profits by lowering risk.

The logic works like this: You wouldn't have a collection on your credit report if you were financially reliable (mistakes happen, this is just the general rationale). A collection indicates that you're having money troubles or are unreliable in general. If either of those assumptions are true, that makes you a much higher risk to new lenders and creditors. In order to provide lenders with the most accurate risk-assessment possible, the FICO credit scoring system docks your credit scores accordingly.

Paying off collections doesn't improve your credit report because collections are always negative. Unlike a credit card or loan account which can be a positive credit entry if you pay your bills on time or a negative credit entry if you don't, a collection account can't swing either way. Once it hits your credit report it deals the maximum amount of damage it can, and paying it off doesn't help you. You could argue that the very act of paying off the collection debt demonstrates responsibility and that your credit scores should increase as a result (and I'd agree with you), but that simply isn't the way the system works.

Credit Scores Improve Over Time Whether You Pay Collections or Not 

Fortunately, this dark cloud of debt collection has a silver lining. Collections don't hurt your credit forever. The FICO credit system takes the age of your credit report entries into account. The more recent an item is, the more relevant it is to your current creditworthiness. As time passes, both good and bad habits can change. This makes the most recent credit entries the most accurate. As such, they carry a greater weight during the scoring process.

This is good news for you if you're trying to rebuild your credit after a collection. Time is your friend. As long as you practice good debt management habits and keep your debt in check, your credit scores will gradually improve in time--whether you pay off the collection agency or whether you don't.

Credit Scores Improve After Collections Are Removed From Your Credit Report 

Once the credit bureaus remove collections from your credit report, you'll generally see a marked increase your credit scores. The FCRA states that collections must be removed seven years from the date the original creditor's debt went delinquent. The delinquency date is usually considered to be the day your original debt went unpaid for 180 days. It doesn't matter how long the collection has been on your report. It's removal rests on the original debt's delinquency. The credit bureaus can remove collections, however, for any of the following reasons:

• The 7-year credit reporting period has expired
• The collection is the result of identity theft
• The consumer successfully disputes the debt's accuracy with the credit bureaus
• The collection agency removes the entry in exchange for payment
• The consumer sues the collection agency for reporting incorrect information and wins 

How Collectors Use the Threat of Credit Damage to Make You Pay

If most consumers realized that paying off collections wouldn't improve their credit scores, many would opt to withhold those payments and put them to better use. Collection agencies are all too familiar with this fact. Because of this, collection letters often note that, if you pay the debt, "your credit report will be updated." This is misleading. The average consumer believes that this means paying the debt will improve his credit rating. In reality, all the collection agency does is update the debt's status to "paid" or "settled." This doesn't improve your credit scores.

Debt collectors also use this angle on the telephone. It isn't uncommon for a debt collector to try to convince a debtor to pay up by using a "but what about your credit?" argument. If the collection agency has already reported the debt to the credit bureaus, the damage is done. The "but what about your credit?" angle deceives the debtor into thinking that paying off the collection will lessen or even undo credit damage that has already occured. This, of course, is untrue.

When Paying Off Collections is a Good Idea

Although paying collections doesn't improve your credit score, your credit report will reflect the fact that you paid the debt. While some lenders see collections as negative no matter what, others will see the fact that you paid the collection as positive evidence that you're making an effort to keep up with your debts and be more financially responsible. Certain mortgage lenders will even require you to pay off collections before approving your mortgage loan. Paying off collection debts also prevents a whole host of negative consequences such as:

• Debt collection lawsuits
• Bank account garnishment
• Wage garnishment
• Civil Judgments
• Property liens
• Asset seizure

This doesn't happen to everyone. Unless the collection agency is working to collect debt on behalf of the government, the agency must sue you and win a judgment before it has the right to utilize more extreme collection methods. 

In the long run, its up to you how to manage your debts in the way you see fit. If that means ignoring collections in order to put food on the table or working overtime to pay your debts in an effort to alleviate your moral compass, so be it. Just remember that whether or not you choose t pay off collections, doing so doesn't improve your credit score. 

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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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Collection Agency Will Sell Your Unpaid Balance After Debt Settlement

One of the tricks in every debt collector's arsenal is offering you a debt settlement. They'll start out high and reduce the amount as time goes by and you don't play ball. If the debt is particularly old, the collector may agree to settle for a paltry sum. Either way, you can rest assured that if you have an account in collections you'll get a debt settlement offer sooner or later. If you plan on taking that debt settlement offer, however, you need to be aware of the fact that the collector may just sell your account to another collection agency after you pay the settlement.

Selling Accounts After Debt Settlement

Ok kids, let me tell you how collection agencies make money. On the front end, they buy debts for pennies on the dollar from creditors and collect on the debts for far more than they paid. The way they make money on the back end, however, is far more sinister.

Here's a story that, for some of you, is all too familiar...

Julia's car was repossessed two years ago. She was left owing $3000 to the bank. The account eventually went to collections. Julia agreed to settle with AAA collection agency for $1700. She used her tax refund to pay off the settlement, breathed a sigh of relief and put the incident behind her.

Six months later Julia starts receiving phone calls from a XYZ collection agency. XYZ collection agency claims that Julia owes them $1550 for an unpaid debt. Julia has no clue what debt they are referring to. After endless phone calls and a whole lot of stress, Julia discovers that AAA collection agency accepted her $1700 settlement payment and then sold the remaining balance of $1300 to XYZ collection agency. XYZ collection agency added $250 in fees and began the collection process anew. It's also reporting the debt on her credit report. She doesn't have the money to settle the debt a second time and, even if she did, she is worried that XYZ will also sell the unpaid balance of her settlement to yet another collector.

This hometown horror happens more often than you'd think. There is no law prohibiting a collection agency from negotiating a debt settlement with you, accepting your settlement payment and then selling the unpaid balance to yet another collector. Remember, debt collectors will make money any way they possibly can. This is a lucrative way. The saddest part? They generally make very little on the debts they sell since these debts are only purchased by junk debt buyers. Unfortunately, junk debt buyers are the worst of the worst and will harass you endlessly for a debt that, technically, you don't owe anymore.

Protect Yourself From Having Your Account Sold After Settlement 

If you want to pay a collection agency's settlement offer but don't want to end up on the hook for the remaining balance somewhere down the line, there is a simple way to get around this: get it in writing. I probably use that phrase more than any other. It's crucial in this business.

Tell collectors to put it in writing.

We are accustomed to doing business with companies who play by the rules. If they say they're going to do something, they usually do it. If they don't do it, its due to an oversight and enough irate phone calls from us later, they do it. Collection agencies do not work this way. If you reach an agreement with a debt collector over the phone, demand that the company put the agreement in writing before you pay them a dime.

Now, the collector is trained to request that you make a good faith payment before the company does anything. You are going to politely decline until the collection agency draws up a good faith statement outlining the terms of the agreement. It's perfectly reasonable to tell the collector that he works for a collection agency and you don't trust them. Tell them they can email you a pdf document on company letterhead outlining the settlement terms, you'll even stay on the phone and wait. But whatever you do, don't pay first!

What to Request on Your Debt Settlement Agreement

A document outlining the amount you'll pay and when isn't enough. Your debt settlement statement has to provide you 100% protection from your account being sold to another collector after you've already paid. This, of course, is the very thing the collection agency doesn't want to give you. Why? Because they have every intention of doing just that. Don't be another victim.

Your statement from the collector should include the following:

• The amount of the settlement
• A statement from the collector noting that, once this amount is paid, your debt is satisfied. 
• A statement from the collector agreeing not to sell the remaining balance to another collector 
• The statement should be on company letterhead and signed

Be polite, but make it clear (and you'll probably have to calmly restate this over and over) that until you have that statement in your hand, you cannot make the first payment. You see, once you make that first payment, they can sue you (paying resets the statute of limitations). If I could spend my days hovering over your shoulder and protecting you from collection scams, I would. Unfortunately, I can't, and no one is going to protect your rights but you. So do it. Demanding a statement containing the terms of your debt settlement agreement is the only surefire way to prevent a collection agency from selling your debt to another collector after you've already paid.

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Debt Consolidation For Accounts in Collection

If old debts that ended up in collections are haunting you at every turn, debt consolidation may be a viable option for eliminating collection accounts and restoring your credit. Whether or not consolidating collection accounts is a smart decision financially depends on how old the collections are, the statute of limitations in your state and when you plan to purchase a big-ticket item that would result in a credit inquiry.

How Debt Consolidation Works

Contrary to popular belief, debt consolidation doesn't combine all of your debts. At least, not exactly. Debt consolidation occurs when you take out a new loan to pay off your existing debt. You then repay the debt consolidation loan over time. Debt consolidation doesn't reduce the amount of debt you owe, but it does make paying your debts much simpler since you only need to make one payment each month rather than the numerous payments you made before getting the loan.

Turn numerous debts into one monthly payment

Consolidating Debts in Collections

Any unsecured debt is available for inclusion in a debt consolidation loan – including collections. If collection agencies are threatening to sue you and the statute of limitations on each account has yet to expire, paying off those collection accounts may protect you from property liens, garnishment and other unpleasant situations in which debt collectors collect the debt by force.

Most collection agencies will set up a payment plan for you if you can't pay off the debt all at once, but being capable of paying off a collection agency debt in its entirety gives you greater negotiation room for a settlement. Although collection agencies will accept partial payments, they'd much rather receive a lump sum. Thus, consolidating collection accounts can be very beneficial for those who have high collections debts they cannot afford to pay.

Debt Consolidation Loan Interest Rates

If you're consolidating credit card debt, medical debt, personal loans, etc., debt consolidation does more than simplify the process. It can actually save you money. This is only true, of course, if your interest rate on the debt consolidation loan is less than the current interest rate your other creditors are charging you.

Unless your collection account started out as a credit card debt and the original contract you signed stipulated that interest charges would continue to accrue should the debt end up in collections, a collection agency cannot legally charge interest on your debt. Unless you can talk the collection agency into forgiving a significant amount of the debt, you'll be paying more over the long run with the debt consolidation loan.

Debt Consolidation Dangers

If you decide that a debt consolidation loan is right for you, make sure to shop around and read the fine print. Not all debt consolidation companies use ethical business practices and, if you fall victim to a scam, you may find yourself in a deeper financial hole than the one you're currently trying to dig yourself out of. Watch out for the following:

• Scam artists: Not all companies that advertise debt consolidation are actually consolidators. Some are debt negotiation companies who take your payments each month and put those payments into a separate account to be used to negotiate settlements with creditors and collection agencies. Not only does this practice destroy your credit scores, it also places you in danger of new collection agencies popping out of the woodwork when your original creditors don't get paid and sell your delinquent debts as a result. 

• High Interest Rates: If you have collections on your credit report, your credit score probably isn't stellar. Like any loan, the interest rate on a debt consolidation loan is based on your credit scores. If you do not qualify for a low interest rate, you may end up paying significantly more over time than if you'd ignored the debts and waited for them to simply fall off your credit report. 

• Property Loss: Many debt consolidation loans are actually home equity loans and secured by the equity you hold in real estate you own. If future financial troubles result in you defaulting on a home equity loan, you could lose your property to foreclosure as a result. 

• Additional Debt: If you include your credit card debt along with collection agency debt in your consolidation loan, it can be very tempting to rack up new charges once your cards are paid off. Even though doing so isn't a bright financial move, I can't even begin to tell you how many people do this. Those individuals are then left paying off their original debt consolidation loan and their new debt.