How Much Will Paying Off a Debt Collection Affect Your Credit Score?

Prior to 2008, paying off a collection account transformed the old account into a new one, which significantly impacted your score. The scoring model, however, changed in 2008; your score no longer decreases when you pay off a collection account and the activity date on the account becomes the date the debt was paid off. Wether paying off the collection account will raise your credit score and how much depends on a number of other factors on your credit report. The scoring model is proprietary information and how a certain item impacts the scoring calculation is not made public. The only certainty is that it will not lower your score.

Debt Collections

Lenders typically sell your debts to a collection agency if they feel they cannot collect what you owe them. If the debt is several years old at that time and the collection agency reports the collection to the credit bureaus, the date of the debt changes to the date reported. This will lower your credit score. If the collection agency tries to collect the debt for a few years and is unsuccessful, it may turn the debt over to another agency. The new agency will report the debt, and the date of the debt will change again. This cycle can go on indefinitely unless you pay off the debt.

Credit Scores

The Fair Isaac Corporation, or FICO, developed the scoring model that determines your credit score. The scoring model is adjusted every few years to accommodate changing conditions. Each credit reporting bureau uses the same basic program. The reason your score may vary in different bureaus is that not all creditors report to all three credit bureaus. Your score is determined from the information in your credit file, also called your credit report. For example, the mortgage crisis of 2008/2009 caused most lenders to increase minimum credit scores required for a loan application approval. In 2011, mortgage approvals typically require scores of 680 to 720. Prior to the crisis, scores of 640 were generally adequate.

Strategy

If you plan to apply for a loan, you should obtain a copy of your credit report two or three months before you apply. You can get a free copy of your credit report once each year at the AnnualCreditReport website. Look for errors on the report and dispute any inaccuracies with the credit bureau. Provide as much proof as possible. This can take as long as two months. If the bureau verifies that an error was made, it will mail you an updated report.

Considerations

If you want to maximize your credit score, pay down any credit card balances to 30 percent of your credit limit or lower and pay off any collection accounts. Late payments on your credit report will lower your credit score. If the late payment was five years ago it will not have much of an impact; if it was a recent late payment, it may keep you from having a loan approved. If possible, make all your payments on time for a year or longer before you apply for a loan. You should also try to pay at least twice the minimum payment required.