Having collections accounts on your credit report is bad for your credit score. But paying off your collections accounts may not improve your credit score. It will depend on which credit scoring model is used to calculate your score and what other items are on your credit report. That said, there are many good reasons to pay off accounts in collections, even if you don't see an immediate bump to your credit score.
Written by Attorney Curtis Lee.
Updated September 22, 2021
Defaulting on a credit account will negatively affect your credit score. The only question is how much it will drop. But does this mean that paying off a collection account will improve your credit score? It’s possible, but it depends. That’s because many variables are factored into your credit score calculation. Some aren’t related to collection accounts while others are directly related.
Let’s take a look at what adding or removing a collection account does to your credit score. But before we get to that discussion, we need to first understand what a collection account is.
What Is a Collection Account?
A collection account is a credit account that is in default. If an account is in default, it often means the borrower hasn’t made a payment on it for 90 days. The creditor will try to collect the debt once it’s in default. It may do so in one of the following ways:
The creditor will assign the account to its in-house collections department.
The creditor will sell the debt to a debt buyer that may then try to collect the debt.
The creditor will hire a third-party debt collection agency to begin debt collection activities.
Regardless of which method a creditor uses, if you have a delinquent credit account, you can expect to get debt collection telephone calls and letters.
The creditor will also report the default to the credit bureaus. It will be listed as a collection on your credit report, which is one of the most serious negative items. Collection accounts are part of your payment history, which has the biggest impact on your score. Your payment history makes up 35% of your FICO credit score.
Just to keep things clear here and in the rest of the article, a credit report contains information about your credit history. Your credit history information is then used to calculate your credit score. A credit score is a shorthand way lenders and creditors determine how risky you are as a borrower. They use your score to predict how likely you are to fully pay a debt or default on it. Your credit score plays a crucial role in your ability to get credit and how much it’ll cost to use that credit.
How Will an Account In Collections Impact My Credit History?
If your credit history lists a collection account, it’ll cause severe damage to your credit score. A credit score drop of 100 points or more is possible. But how much your credit score falls will depend on other factors. For example, the higher your credit score, the more damage a collection account will have when added to your credit report. This might seem unfair, as someone who’s earned a high credit score might feel they deserve a little slack on a first-time past-due account. But it makes sense.
Someone with a good credit score is supposed to be at a lower risk of default than another person who has a lower credit score. If the person with a high credit score has a collection account reported on their credit history, it’s an unexpected event. The more unexpected the negative item, the bigger the red flag for lenders.
It’s like that friend you have who’s always late to your meetups. If they show up late to a get-together this weekend, you’re not surprised at all and probably wouldn’t think twice about it. But if you have a friend who’s always punctual and they end up not showing up at all, you’ll probably be surprised. In fact, you might even get worried and call or text them to make sure they’re okay. The more dramatic reaction you had for your punctual friend is similar to how credit scoring models view someone with a high credit score who has a collection account.
Keep in mind that a substantial decrease in your credit score won’t be the only negative consequence of defaulting on your credit account. Before it got to that point, you had to miss several payments. If the collection account is the result of an unpaid credit card balance, you probably missed three monthly payments. Your creditor reported those late payments to one or more of the three major credit bureaus — TransUnion, Experian, or Equifax — which calculate credit scores and compile credit histories.
With a collection account in your credit history, you’ll not only have a lower credit score but also a more difficult time getting new credit. The next time you apply for credit like a loan, mortgage, or credit card, your prospective lender will pull your credit report and see that you defaulted on a debt. They may then think you’re more likely to default again in the future and perceive you as a higher risk.
The lender may then refuse to extend credit to you or offer you a loan with less generous terms to offset the higher perceived risk of default. This could include:
Higher interest rates;
Additional fees or penalties; and/or
Lower credit limits and/or less money loaned out to you.
A collections account can also cause other credit problems. For example, some lenders, especially banks that issue mortgages, have policies that prohibit their lenders from issuing mortgages to borrowers with a delinquent unpaid debt in their credit history.
How Long Will a Collections Account Impact My Credit Score?
If a collections account ends up on your credit report, it’ll hurt your credit score for up to seven years. But it’s not all bad news. Over time, the negative effect the collection account has on your credit score will diminish. For instance, a six-year-old debt in collections will have a smaller effect on your credit score than a brand-new collections account, which will likely do major damage.
After seven years, the collection account will come off your credit report because of the statute of limitations. This doesn’t mean you’ll no longer owe money on the debt. Instead, it means the debt collector or creditor can’t sue you to collect the debt.
In addition to letting time do its work, you can reduce the negative impact of a collections account by exercising good debt management habits and building your credit. These can help repair your credit and, depending on your personal finances, could overshadow any negative effect the collection account has on your credit score.
Will Paying Off a Collections Account Improve My Credit Score?
It seems like the obvious answer to this question is “yes.” But like many questions about credit scores, the real answer is “it depends.” There’s no definitive answer because of the various factors credit bureaus use to calculate credit scores. Some of these factors include:
The number of collection accounts on your credit report;
The age of the collection account(s);
Other negative items that might bring down a credit score, such as a bankruptcy; and/or
The algorithm the bureau uses to calculate your credit score.
Credit Scoring Algorithms
Companies use different algorithms to calculate credit scores. The newer algorithms include FICO 9 and VantageScore 3.0 and 4.0 scoring models. If your score is calculated using one of these models, then paying off a collection account may improve your credit score. This is because these scoring models ignore any collection account that’s reported as paid in full and has a $0 balance. While this is great, these algorithms aren’t currently widely used.
The older algorithms, such as FICO 8, factor collection accounts into your credit score. This is true whether or not you’ve paid the account off. Under FICO 8, if a collection account is reported on your credit history, it’ll hurt your credit score. To put it another way: The fact that the account went to collections in the first place matters more than whether or not it’s paid.
Even if you settle your collection account, the debt collector doesn’t have to remove it from your credit report. The Fair Credit Reporting Act (FCRA) only requires them to report the appropriate change to the status of the account. So if you pay off a collection account in full, the account will still show up on your credit report until it comes off seven years after it was first reported.
Paying Off an Older Collection Account
If you have a collection account that’s old and close to the statute of limitations, it might be best from a financial standpoint to let the account age off. By letting it go, it’ll no longer show up on your credit report. When that happens, it’ll no longer affect your credit score.
If you decide to pay off the old collection account, do it in full. If you make a partial payment, it’ll reset the statute of limitations clock. This means the creditor or debt collector has another seven or so years to file a lawsuit against you to collect the debt if they choose to take that route. And if you manage to settle a debt for less than what you owe, be sure to get a clear, written agreement with the debt collector that says the debt settlement amount will be accepted as full payment and there’ll be a zero balance.
Are There Advantages to Paying Off an Account in Collections?
It might seem like paying off a collections account isn’t worth the cost. But there are several compelling reasons to pay off an account in collections (except very old accounts).
Paying the account can keep you from getting sued. If you’re sued and you lose your case, the creditor will receive a court judgment against you. This is bad for your credit history and can lead to wage garnishment.
Paying off a collection account prevents you from additional interest and fee charges. Collection accounts often get sold several times to various debt buyers. Each new debt buyer may charge additional interest and fees, which increases your overall debt balance.
Paying off a collection account looks better to prospective lenders and creditors. The account might still show up as “settled” in your credit history and lower your credit score, but it’ll still leave a better impression than having an open collections account. Determining creditworthiness is largely a numbers game, but human emotions still play a role. This is particularly true for large credit decisions, such as those involving car loans or home mortgages.
It can stop the harassing calls and collection letters from debt collection agencies trying to collect the debt.
Debt collection accounts will hurt your credit score. Since credit scores are calculated using many variables and with different scoring models, it’s difficult to know how paying off a collection account will affect your score. You may see your score increase significantly or by just a few points. Even so, there are good reasons to pay off a collections account. If appropriate, it should be part of a comprehensive credit repair program. To learn more about how paying off a collection account will affect your credit, schedule a free consultation with an accredited, nonprofit credit counseling agency.