Collections and Credit Rating

Your credit rating encompasses the information on your credit reports and your credit score as calculated by FICO and the Equifax, TransUnion and Experian reporting agencies. Many credt-related factors influence your rating, the Federal Reserve Bank of San Francisco explains. You look bad to creditors when you stop paying your accounts and they get turned over to collection agencies.

Definition

Collections on your credit report refer to accounts that have been turned over to a debt collection agency. The original delinquent account shows up, as well as a collections entry. Liz Pulliam Weston, a MSN Money website writer, explains that lenders usually write off unsecured debts like credit cards that go six months with no payment. This action does not absolve you of paying the debt. The lender gets a tax benefit and then sells the account to a collection agency, which continues to pursue you for payment.

Effect

Collections fall under "payment history" when your credit score is calculated, according to the MyFICO scoring information site. This area accounts for 35 percent of the total score, so collection debts drop your score significantly. Lenders who see collection entries on your credit reports may reject your applications because they know you defaulted on other bills. Collection agencies can often take you to court, depending on your state laws, and win a judgment against you for the bill. The court action is added to your credit reports and makes your rating even worse.

Considerations

Collection agencies sometimes agree to stop reporting an account to the credit bureaus in exchange for a lump sum settlement. Offer less than the actual amount because they pay very little for debts and make a profit even if you get a discount. Ask them to provide written documentation of their promise to stop reporting the item before you send the money, Bankrate debt adviser columnist Steve Bucci recommends. Your credit rating improves as soon as it is gone.

Time Frame

Collections do not stay in your credit bureau files forever. These entries get erased seven years from the day you missed your first payment, even if you never pay the bill, the Federal Trade Commission explains. Their effect goes down as the year pass because creditors pay more attention to your recent records. Beware of trying to settle a collection account that will drop off your reports soon. Bucci warns that this might rekindle the agency's interest in aggressively pursuing it if you do not reach a settlement agreement.