Why Will Paying Off Collections Hurt Credit Scores

When you are trying to improve your credit score, you may think that paying off old collections will help. Think again. You may be surprised to learn that paying off old debt could hurt rather than help your credit score.

Misconceptions

If you are working to boost your FICO credit score, there are a number of steps you can take. Some are obvious, such as staying current on paying your bills. But others are not so clear and may be counter intuitive. You may know that your credit score is calculated by considering a number of factors. Your payment history and the amounts you owe make up 65 percent of your credit score. So, it is natural to think that if you pay off that old bill your credit score will improve. But it depends on when you pay off the debt.

Effects

According to the Fair Issac Corporation, which calculates FICO scores, there are two factors that it considers regarding collections. These are whether you have any collections on your credit report and the date they appeared on your credit report. When you pay an old debt, the credit bureau adjusts the date on the collection, making it a current event. In the FICO software's algorithm, current events are weighted more than older items.

FICO gives more importance to the entry of the original creditor compared to a collection agency. If enough time has elapsed and the account has been turned over to a collection agency, the original creditor may have reported a balance of zero. Fair Issac spokesman Craig Watts told MSN Money, "If the trade line balance is showing zero, you're not going to help your FICO score by paying off a collections account."

Considerations

You may feel a moral obligation to pay your old debts, but if you are trying to improve your credit score for a specific purpose, such as getting the best possible mortgage interest rate, you should wait until after you close or make the purchase to pay off the collection. If the collection is on a debt that you have disputed, or if you have some other reason why you believe you do not owe the money, you can do nothing and it will drop off your credit report seven years after the last activity on the account. So if the collection was reported in January 2006 and you continued to make payments on it until June 2006, it will come off your report in June 2013.

Either option will save you a lowered credit score and possibly thousands of dollars in increased interest payments than if you had chosen to pay off your old debt at the wrong time.