Unpaid debts often end up being sent to collection agencies. If a collection agency inserts a collection account on your credit report, your credit will suffer. While paying old debts demonstrates responsible financial behavior, it is imperative that you do so carefully to avoid additional credit damage.
Facts
Many consumers pay off collection agencies believing that doing so will improve their credit. While submitting payment on an account that is in collections won't result in the account being removed from your credit report and won't improve your credit score, doing so won't directly damage your credit score either. The account will simply update as "paid" on your credit report.
History
Prior to the release of the Fair Isaac Corporation's FICO '08 credit scoring system in February 2009, paying old collection accounts could lower your credit score. The old credit scoring system placed an emphasis on recent account activity. Accounts that displayed recent activity carried a greater weight with the scoring system than dormant accounts.
Thus, by submitting a payment on a collection account, an individual was essentially updating the account. When this occurred, the computerized scoring system assigned greater importance to the derogatory notation -- damaging the debtor's credit rating. As of 2010, Fair Isaac's credit scoring system no longer penalizes consumers for paying off old debts.
Considerations
If you settle your debt with a collection agency rather than paying it off in full, the collection agency may then sell the remaining unpaid balance to another debt collection company. Provided the credit reporting period of seven years has not already expired, the new collection agency can add yet another derogatory tradeline to your credit report and further damage your credit score -- an event that would not have occurred had you not attempted to pay a portion of the debt.
Warning
While paying a collection agency doesn't directly impact your credit score, paying only a portion of what you owe on an old debt places your credit in jeopardy. Each state has a statute of limitations regulating debt collection lawsuits. Making a payment -- no matter how small -- restarts the clock on the statute of limitations. This can give a collection agency that did not previously have the right to sue you a fresh opportunity to take legal action.
Should the company file suit against you and win, a judgment will appear on your credit report. Judgments, like collection accounts, are negative entries that damage your credit rating considerably. The Fair Credit Reporting Act notes that, depending on your state's statute of limitations, a judgment can appear on your credit report for longer than seven years.
Prevention/Solution
If you settle a debt with a collection agency, you can protect yourself from additional credit damage by obtaining a written agreement from the company not to sell the remaining balance to another company. If you submit payment in full, ask for a statement from the company reflecting that your account now carries a zero balance to serve as proof of your payment in the event your paid off debt ends up in the hands of yet another debt collection firm.
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