Why You Should Never Pay Collections
You will learn why you should never pay collections accounts. I know you may have heard this before, however I will break this all the way down.
#1 COLLECTIONS MYTH
For starters, begin by addressing the most common myth I hear about regarding collections.
Your score will go up a lot when after you pay your collections off.
That leads me to the question I get asked a lot by my clients:
“How much will my credit score go up after I pay my collections?”
The answer is, not a single point. I have argued with people about that fact for years.
However, what people fail to realize is how FICO scores are actually calculated.
There are 5 Factors that make up the FICO score.
Important to understand all of them.
Please refer to a previous blog title “5 REASONS YOUR FICO SCORE IS
LOW” to better understand how credit scores are calculated.
Collections damage the most important factor of your FICO score: Payment History.
This factor accounts for 35% of your credit score. Which is worth just about 200 points.
Payment history is simply your record of paying back debts.
When you pay these debts back late, you will get dinged for a ton of points.
WHAT IS A LATE PAYMENT REALLY?
A late payment is when you pay 30 days after the due date, not when it’s only 5 days, or 15 days or even 29 days late.
It only affects your credit score when it is 30 days late or more.
If you make it all the way to collection status, that means you have not paid this debt for 180 days.
So, when you have a collection, that you have not paid that account for 180 days or more.
Which also means your score is being killed by this debt you are not paying.
Basically, your score will be dramatically dropped as payment history accounts for nearly 200 points of your FICO score.
PAID COLLECTION STATUS
WILL NOT IMPROVE FICO SCORE
Now that we all know what payment history is and how it can affect your score, let’s go into what happens when you pay a collection.
Let’s say you paid in full a collection debt and you are happy because you believe your score will go through the roof now that your credit report will be updated.
The update will say that this account is now a ‘paid collection’, instead of a collection with x amount of dollars owed.
That new status sounds a lot better than the unpaid collection it once was. Problem is, it’s still a collection.
Remember what we talked about earlier. Payment history.
WHAT IS A COLLECTION?
A collection means you have not paid for 180 days or more.
Paying a collection in full or partially actually just restarts the date of last activity.
Much more to come about this shortly, and it does not improve your payment history situation whatsoever.
It may look a little better to a creditor, but it will not earn you points on that FICO score.
But what about credit utilization you ask?
Doesn’t it improve it since it’s no longer an unpaid debt and has $0 balance?
No! Let’s talk about it.
COLLECTIONS DO NOT
AFFECT CREDIT UTILIZATION
Credit utilization is worth 30% of your score, which is 165 points.
This is something people get wrong often, it’s because they mistake debt in general for credit debt that affects credit utilization.
To understand the difference you will need to know what Credit Utilization.
Also known as Debt-to-Credit Ratio actually is.
Not to be confused with debt-to-income-ratio.
But, credit utilization is referring to your percentage of available credit that is currently being used.
The calculation is your credit card balances divided by your credit limits.
For example, if you have a $1,000 credit card, and you have a balance of $500, your credit utilization is at 50%.
Calculation: $500 (balance) divided by $1,000 (credit limit) = .5 which is 50%.
CREDIT CARDS ONLY
Here is the major key, the only type of debt that affects credit utilization is credit card debit, also known as a revolving debt.
Unpaid cell phone bills, medical bills, utility bills, etc. are debts that do not factor in to the equation for credit utilization. They only affect payment history.
The same is true for any car loans, home loans/mortgages, aka installment loans. They only affect payment history.
So, again, paying a collection will not improve your FICO score.
A collection only affects your payment history, not your credit utilization.
DON’T RESTART THE DATE
OF LAST ACTIVITY
This was mentioned earlier, date of last activity. This is very important to know and understand when it comes to collections.
The date of last activity means just that, the last time you made a payment on the debt.
When an account goes to collections it means that a collection agency bought your debt for pennies on the dollar.
When the collection company buys your debt from the original creditor it already has at least 180 days of inactivity, so that 180 days ago is your date of last activity.
DO NOT PAY A COLLECTION
When you pay a collection, this restarts your date of last activity.
Why is that important you may ask. Because the Statute of Limitations is 7 years.
This statute is in the Fair Credit Reporting Act to protect consumers from being negatively affected by old debt.
To paraphrase it, the statute says any derogatory or negative accounts/items that are 7 years old shall be removed from your credit report.
Once you pay a collection partially or in full you restart that 7 year clock. You do not want to do this.
STATUTE OF LIMITATIONS
FOR COLLECTING A DEBT
Legally in most states a debt cannot be collected on after 4 years.
During that time period is when you need to worry about being sued for a debt.
After 4 years they cannot legally come after you for a debt.
You only need 3 more years for the credit bureaus to remove it from your credit reports.
Don’t expect them to remove it automatically, you will need to dispute it and demand it be taken off once it’s past the 7 years.
THE ONLY TIME YOU
PAY OFF A COLLECTION
There is an exception to the rule.
Perhaps there is a time when you can pay off a collection.
Keep in mind the word ‘can’.
Not that you should, but you can pay a collection off if the collection agency agrees to and sends you a ‘pay-to-delete’ letter.
What is a Pay-to-Delete Letter?
It’s a letter that collection agencies will give you as an incentive to pay a debt off, usually in full.
The letter will state that the collection company will remove this debt from your credit report once payment is received.
In most cases they will demand full payment for them to send you this letter.
It is also true that most times they will say they cannot produce such a letter.
Sometimes you will have to be savvy to get them to give you this letter.
They may agree to send it once you make the payment, which is not recommended because they can take the payment and never remove.
It’s better to get it before you pay, otherwise you have no other leverage to get that letter.
HOW TO REMOVE COLLECTION
FROM CREDIT REPORT
Once you receive the letter you can make copies of it and send it to all three major credit bureaus (Equifax, TransUnion, and Experian) along with copies of the receipt for proof of payment.
When you can pay a collection and get it removed immediately from your credit report, that’s the only time you may consider it.
Wouldn’t say you should do it, because in most cases you can dispute the item and get it removed.
Wouldn’t You Rather Save That Money?
You should want to save your money, considering the payment you would be making is to a collection company.
Not your original creditor that already charged-off the debt and got paid a portion of your debt by the collection company that bought it.
You do not legally owe any collection company.
They are not your original creditor.
You must look up the Fair Debt Collection Practices Act (FDCPA) to learn your rights.
A collection account is very harmful to your FICO score as you know very well now.
Also, it is important to know that collections do their most damage when they first appear on your credit report.
A tactic used by collection agencies often, tends to be increasing your debt amount.
This is done to basically update the debt to try and affect your score, so that you will want to make a payment ASAP.
Do not fall for it. Dispute. Dispute. Dispute!
Remember, the only factor collection accounts affect are your Payment History. Not Credit Utilization.
Also remember that paying a collection debt in full does not earn you points because it is still considered a collection, and affect your payment history.
Always be working to remove the collection through the dispute process or negotiating with collection company to get a pay-to-delete letter.
I hope this was helpful, please leave comments and questions below.
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