Many Americans believe that paying off their collections is the best way to improve their credit rating. However, according to Aazim Sharp, president of Leaf Credit Solutions, Bloomfield, New Jersey, the opposite is true.
Sharp contends that what collection companies don’t want consumers to know is that paying off your debt can damage your credit score. Here are his three reasons why:
First, when a consumer starts to pay off a collection, it updates the Statute of Limitations (SOL) on that debt. Every account you owe money on has an SOL, the timeframe of how long by law a creditor can collect on that debt. The SOL varies based on the state where you live or the state in which you acquired the debt. It also varies based on the account type
Many states have a SOL of four years on credit card and contract debt, which means the collector can only collect for four years beyond the Date of Last Activity (DOLA) of that account. Mortgages in many states have a SOL of seven years. When a consumer makes a payment on a collection account, the DOLA is updated to the date the last payment was made.
Secondly, paying off a collection will not change your account status. If you have an account in good standing, it reports as a “1” status. For example, a paid as agreed mortgage reports as a M1 status, and a paid as agreed revolving account reports as a R1 status. When a consumer makes a late payment, the account status begins to change. The first late payment changes the status to “2” and as the account becomes further behind, the numbers increase until the account ends up in a collection as a “9” status.
All collections report as a “9” status and damage your credit score, which is the mathematical model that depicts a consumer’s risk of going 90 days late on an account. What most consumers don’t know is that when you pay off a collection, your account still remains a “9” status. Creditors still look at that account as a defaulted account and still consider you as a high of a risk for defaulting on a loan in the future.
The third reason paying off a collection will damage you credit score is that it will update the “Date Reported,” or the date your account went late, on your credit report. The “Date Reported” can vary based on the account type. Most negative accounts remain on your report for seven years. Tax liens, bankruptcies, and other government accounts can remain on the credit report for 10 years Other IRS-type debts can remain on the report indefinitely.
The “Date Reported” starts from the date you went late, not your date of last payment like the SOL. Many creditors will update this date when a collection is paid off, even though they are not supposed to by law. However, if you are in a re-payment plan for a debt and miss a payment, a creditor can legally update this date on your credit report.
Even if you are able to pay off a collection balance completely, creditors will still see you as a high risk. The only way to improve your credit score is to delete the negative item from your report, according to Sharp. When a collection item is deleted, its history and its “9” status collection is deleted as well. If you do pay off a collection, obtain a Pay to Delete letter that shows the item will be removed from your record, Sharp advises. And be sure to review you report to ensure the negative item has actually been deleted.