Once you fall behind on a debt, your credit score will begin feeling the impact. If you stop paying altogether, the creditor will eventually turn the account over to a collection agency for recovery. Credit scores are calculated using a unique formula based on a variety of factors and information reported by creditors. If your account is in the hands of a debt collector, paying it off can increase your score. The amount your score can improve will vary depending on how old the account is, how it is reported and the number of other accounts you currently have in good standing.
Impact on Your Score
According to MyFico.com, payment history has the most significant impact on your credit score. Your payment history on all your accounts makes up 35 percent of your score. Generally, creditors begin reporting delinquent accounts about 30 days after you miss a payment. However, some may report the delinquency sooner. If the creditor is unable to recover the debt within 180 days, they assume they will be unable to collect and write off the debt as a loss for tax purposes. The creditor will report the debt as a charge-off, which does not relieve your responsibility to pay the debt. The creditor can continue to attempt to collect the money you owe using their in-house collection department or may choose to sell the debt to a third-party collection agency.
Age of the Debt
Once the creditor reports a charge-off, it remains on your credit report for seven years. The amount of points your score will drop corresponds to how high your score was before the account went to collections. The higher your score, the more significant the negative impact that the unpaid debt will have. As the years go by, the impact will gradually diminish. The number of points your score will increase once you pay the account off depends on how recently the creditor reported the debt. For example, if you pay off an account that was charged-off last year, your score will rise more points than if you paid off an account that has been lingering on your report for six years.
Statute of Limitations
You can wait for the account to fall off your report completely or you can pay off the debt. If you are nearing the seven-year statute of limitations, make sure you are capable of repaying the debt before making a payment. A single payment can restart the clock all over again and keep the debt on your credit report for an additional seven years.
Negotiating a Pay-Off
You can generally negotiate collection accounts for less than the original balance, especially if the debt is old. If you are able to reach an agreement, get it in writing. Ideally, you want the collection agency to delete the account from your credit report. Even if the account is paid, it will still appear on your report. The next best option is to have the collection agency report the account "paid as agreed" instead of "settled."
Establishing Good Credit
You can minimize the impact the collection account has on your score by adding positive account information. If you have other accounts, keep paying them on time. Try keeping your balances as low as possible to improve your debt-to-credit ratio. If you do not have other lines of credit, consider applying for a credit card with a low limit. Keep the balance low and pay more than the minimum. Since an account in collection can hurt your ability to obtain new credit, you might want to consider taking out a secured credit card through a reputable company. Instead of the credit card issuer assuming the risk, you put up the collateral. The credit card company will report to the major credit bureaus, which can add a positive account to your credit mix.