Paying off old debts doesn’t always improve credit score
If you’re working on improving your credit score, paying off old debts seem the obvious thing to do. While paying off old debts should be high on your priority list, you should also keep in mind that in some cases it may actually lower your credit score!Paying off old debts can affect your credit score in various ways, depending on how the type, & age of the delinquent account being paid off, as well as on how the creditor reports the payment(s) to the credit bureaus.
When you pay of an old debt, in some cases the account’s age may get updated. Because Fico score formula puts high emphasis on the account age (more than 70% of your score is made up by information from the past two years), in some cases paying off a delinquent account may actually drop your score!
Paying off an overdue account
If an account is simply over due and shown as outstanding debt, paying it off (or making payments against it) will certainly improve your credit score. While paying off the account won’t delete the late payment from your credit report nor will cancel their adverse affect, returning to “current” status and reducing the overall amount owed will raise your credit score.
Paying off a charge-off
This is a good example where paying off an old debt may actually lower your credit score.
Charge-off accounts are accounts that has been write-off by the lender and (usually) sold to collection companies.
Since the lender has written off the account and sold it to collection, he won’t be accepting any new payments. New payments (full or partial) can be made only to the collection company (which now owes your debt).
The problem with collection companies is that in many cases the payment makes the account to appear as more recent. Because Fico score formula strongly factors the account’s age – paying off a collection account may backfire and lower your credit score rather than improve it.
Debt Settlements
If you choose to settle with the lender for less than the total amount owed, the settlement agreement will be reported to the credit bureaus and will appear on your credit report.
Unless reported otherwise by the lender, FICO score considers debt settlement as “not paid as agreed” account, which is still a delinquent account. Because of this, your score won’t improve even after you pay off the agreed settlement amount.
Furthermore: in some cases the account age may update to reflect the settlement date. A younger delinquent account means greater negative effect on your credit score, which will drop because of the settlement.
More about debt settlement and credit scores here.
So why pay off old debts anyway?
Even though paying off an old debt may adversely affect your credit score, it doesn’t necessarily mean that you should avoid it.
There are many reasons why you need to pay off all of your debts, old & new.
Old debts never go away. You can (and probably will) get sued. Additionally, most lenders will ask you to resolve any past debts prior to approving you for new credit. More about why pay of old debts here.
Is the debt about to fall off your credit report?
If the debt is very old (6 years or more) and about to fall off your credit report, it may be smarter to pay off the account AFTER it falls of the credit report and no to risk making the delinquent account younger.
Is the debt time bared
Before contacting a creditor regarding an old debt, you must check your state laws for the statute-of-limitation on that debt. Unlike credit reporting time limit (7 years for most debts) that does not restart, the statute of limitations clock is re-started every time someone doses something with the account, so even contacting a creditor can re-instate the debt as currently collectible, which can drop your score.
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