Home Investing Personal Finance Does paying off collections improve credit score?

Does paying off collections improve credit score?

credit score

Your credit score have a huge influence on your overall financial health. Want to know, how? Well, for instance, when you borrow money with a less-than-ideal credit score, you will likely pay higher interest rates. Larger loans, such as mortgages, will cost you more too. By not improving these scores, you are, in fact, wasting thousands of dollars per year. Add up the amounts, and you will see hundreds of thousands of dollars that you will be losing in your lifetime.

Why let your credit history stay in that condition? It would serve you well to both earn and maintain your scores. For people who are just entering the credit game, great mistakes await them. Such as allowing your debt to become collections, i.e., go into default. Accounts that have become collections will show up as defaulters on a credit report. Here’s how you can understand this process better:

What is a debt collection account?

debt collection account
Image credits

It is a credit account that is now severely past-due. It is also one of the several worst entries you can have on your credit report! The situation becomes graver when you have multiple such accounts on your report. It can deteriorate as you add more recent collections to your credit report.

The chronological order of events from defaulting debt to collections

Simply miss paying an installment, and you are probably fine. However, consistently failing to honor your financial obligations can drag you into a downward spiral. In your creditor’s eyes, it is plain that you won’t be paying them back anytime soon…if ever. They will have little choice but to use any means necessary to recover their losses. One way through which they can do that is by selling your debt to someone else. Now you are beholden to a collection agency.

The thing to remember about such an agency is that it specializes in recovering outstanding balances. They are a third-party that is well-versed in commercial debt collection. To get you clear your defaulted debts, they may report your account to a credit reporting agency. Consequently, a collection account makes it to your credit reports.

What does that mean for you? You will find it becomes harder for you to borrow money. Any future loans will require you to pay the debt you owe first. Is this legal? Completely!

What do your credit scores really mean?

Now we have been talking about credit scores a lot. But what do they even mean? How low do yours stand, and what does that signify? It is easy to determine which range your credit score falls in:

  • Anything that is 750 or above means that you have excellent credit
  • Below that and up to 700, you will find yourself in the good zone
  • A score lower than that up to 650 is considered fair
  • Fall lower than that up to 550, and you are entering the poor credit score zone
  • Any score below 550 becomes bad

Bad credit scores are usually the result of unpaid debts that are now displayed on your credit report.

Help! My account may go into collections!

If that is yet to happen, then you can pay off or settle your collections. Doing so is likely to improve your credit score. But how do you prevent that? By improving your credit utilization ratio, i.e., the amount of credit you use minus the total credit limit.

Will paying off my old debts improve my credit score?

credit report
Image credits

The bad news is that it didn’t use to be so cut and dry. Besides FICO, a type of credit score, you have other scores you should be paying attention to. Another one that matters is Equifax, Experian, and TransUnion’s VantageScore. So, the bad news that we mentioned? The older versions of both these scores were more interested in whether you have a delinquent account or not. So, it wouldn’t matter how big or small an amount you owed. What’s more, most lenders use these two types of scores to weigh whether they should risk their money by loaning it to you or not.

But we also have good news. The newest versions, i.e., FICO 9 and VantageScore 3.0, exclude any collection accounts once you pay them off. Therefore, if you do pay off those collections, you can improve your credit score!

A word before you go…

Now it is true that to improve your credit score; you need to label all collection accounts either as current or paid. But don’t just take the debt collector’s word for it and pay off the amount. Sit down with them to discuss various payment scenarios. Ask them what the outcomes of each scenario would be. After all, you don’t want to both pay a debt collector and then discover that the collection is still on your credit report. Verify the debt collector’s reputation before you hand them a way to influence your financial future!

ABOUT Alycia Gordan

Alycia Gordan is a freelance writer who loves to read and write articles on healthcare technology, fitness and lifestyle. She is a tech junkie and divides her time between travel and writing. You can find her on Twitter: @meetalycia