Collection Accounts: How old debt wrecks your credit score

Collection accounts, old debt, and bad debt. One of the many items that can make you sad for being an adult. Having collection accounts suck. No way around it. 

Collection accounts are stressful. I know from experience. I have had to deal with them first hand. I’ve also helped dozens of other people get rid of their collection accounts, bad debt, and old debt. 

And there are a LOT of people who deal with collection accounts. So if you are embarrassed about having collection accounts, don’t be. It happens to millions of people. 

Yes, sometimes a person can have a collection account (or accounts) because of their own friviouless and undisciplined nature. But most people have collection accounts simply because of crappy life circumstances. An unexpected hospital visit. A car accident. A scammer. 

But before we get into the meat and potatoes of how you can deal with collection accounts let me show you how the credit “game” is played.

There are three credit reporting bureaus:

1. TransUnion
2. Experian
3. Equifax

Any creditor that you have will report to any one, two, or all three of these bureaus at least every few months. They will tell the bureaus (1) if you pay your bill on time, (2) how much you owe, and (3) your interest rate. Once you pay the bill off in full, they will report that as well.

Then based on the information that your creditors report to the bureaus, they will give you a credit score. All credit scores (excluding a 0 credit score) range from 300-850. Here is the breakdown of credit scores:

• 300-579: Very poor
• 580-669: Fair
• 670-739: Good
• 740-799: Very Good
• 800-850: Exceptional

Typically when applying for a loan, if you have a 700 credit score you will be qualified for close to the lowest interest rate and best terms. So if you have a 720, don’t be upset because you really want a 850, you’re still in really good shape. 

This leads me into my next point. The reason that you want a good credit score is that if you have to borrow money (you should always try to pay cash first and not borrow money) you look more desirable to lenders.

Someone with a 750 credit score is a much more desirable risk for a bank to take than someone with a 500 credit score. Someone with a 500 credit score probably has debt that has defaulted and is in collections, they have probably missed payments, maybe had a repossessed vehicle, etc. The person with a 750 credit score has probably not had any of those things happen (at least not in a very long time). 

Here are the different parts of a credit score and their weights:

1. Payment history (35%)
2. Amounts owed (30%)
3. Length of credit history (15%)
4. Credit mix (10%)
5. New credit (10%)

If you would like a brief overview of each of the parts of your credit report, click here.

So let’s get into the reason that you clicked on this link in the first place.

What do you do with collection accounts that are on your credit report?

(1) What is considered a Collection Account

A collection account is an account that you had with a lender that you did not pay for more than a few months and has been sold to a debt buyer. 

Let me break down that sentence a little.

An account (for the purposes of this article) is a debt that you had with someone (think of a car loan, medical bill, credit card, etc.) that you did not pay. The reasons for you not paying are irrelevant. If you just skipped out on the bill, if life’s circumstances threw you a curveball and you couldn’t pay, if you had no idea that the bill even existed in the first place, or if it was fraudulent don’t matter. 

If the creditor (the bank, hospital, credit card company, etc.) says you did not pay them for more than 90 days they likely charged off the bill.

This leads me to the next definition: charge off.

A charge-off is the action of a creditor taking the bill off of their books because they believe that they won’t get paid. But just because an account has been charged off by a creditor, doesn’t mean that it is necessarily a collection account. 

Once an account has been charged off, it will probably be purchased (along with hundreds or even thousands of other charged off accounts) by a collection company. Once it has been purchased by a collection company, it is considered a collection account.

(2) How Collection Accounts Affect Your Credit Score

Collection accounts are horrible for your credit score. If you have collection accounts, you need to try to pay them off ASAP.

No one really knows how much a collection account actually pulls down someone’s credit score. TransUnion, Equifax, and Experian hold the algorithm to calculate credit scores extremely close as trade secrets. But in my experience (in my previous life as a banker), one collection account that is 1-3 years old generally pulls down a credit score by 50-75 points. 

The problem is that most people who have collection accounts, generally have a lot of them. Usually because of hospital bills. 

What is known is that when a collection account first appears on your credit report, it will have the worst effect on your credit score. As time goes on, that effect will be less and less. And eventually the collection account will fall off of your credit report. This usually happens after seven years. 

But please don’t think that you should just wait for it to fall off because seven years is a LONG time for you to have subpar credit.

(3) How much/fast will your credit score improve after paying off a collection account?

This is a somewhat difficult question to answer. It depends on a few different inputs. 

1. How old was the collection account?
2. How much was the collection account?
3. Did you pay it off in full or settle it?
4. What kind of debt was the collection account?

Generally speaking, each month that a collection account sits on your credit report, it hurts your credit a little less. You may not see any difference in your score for quite some time, however.

In my experience, the size of the collection account ($50 compared to $5,000) doesn’t seem to matter very much. The way that a larger collection account affects your credit score is determined more on what type of debt it is. For example, an auto repossession or a foreclosure debt is going to generally be larger than a credit card collection account. And an auto repossession and foreclosure will lower your credit score more than something like a credit card or student loan collection account.

If you pay a debt off in full, sometimes the collection agency will take it off of your credit report entirely as if it never existed in the first place. But if you settle the debt for less than you owe, you will rarely see it taken off of your credit report. The entry for that debt will simply say, “Settled for less than the amount owed”.

(4) How to Go About Paying off Collection Accounts

Here is how you should go about paying off your collection accounts. What you need to make sure that you do, what you should ask for, and what you should avoid. 

As I’ve said a few times in this article already, collection accounts are KILLING your credit score. You should take care of them ASAP. Even if the accounts are really old and not hurting your credit score as much as if they were brand new, I promise that you will feel much better by paying them off. I know this from experience.

Every time that I have paid off a collection account, I have had a lot less financial stress in my life.

Steps to pay off a collection account:

1. Start with your smallest collection account: Each collection account you pay off will help your credit score. In my past experience as a banker most collection accounts that I saw were for less than $500. Even if you have a few that are large, knock out the smallest ones first. Your credit score will thank you and your financial stress level will shrink.
2. If the collection account is $250 or less, just pay it off in full: You don’t want to spend a lot of time negotiating for a $135 bill to be reduced to $40. It’s not worth your time and it will take them time to send that offer to you in writing.
3. Get all collection accounts payment offers (whether it’s paid in full or settled) in writing: OMG this is important. As any reasonable attorney will tell you, “If it’s not in writing, it didn’t happen.” You MUST get any amount owed or settlement offer in writing. An email will work just as well.
4. Send payment in a cashier’s check if possible: Do not give any collection agency access to your bank account. I have never had this done to me but I have heard of times when a collection agency will remove more money from your bank account than you agree on. If you have to give payment over the phone (which sometimes happens), then give it on a prepaid debit card.
5. Watch your credit profile like a hawk after you pay off a collection account: It will probably take a few weeks or so for the collection account that you just paid off to either fall off of your credit report entirely or report as “Paid in full” or “Settled for less than the amount owed”. That is completely normal. But if it has been more than a month, call the collection agency and figure out what is going on.
6. Remember, a collection agency representative’s goal is to have you pay as much as possible: Collection account representatives are not your friend. They are not trying to help you. They are simply trying to collect on a debt. No more, no less. Remember that. You must do what is best for yourself while they are doing what is best for them. If a collection agent is being rude or dismissive, hang up and try again later. You’ll get to talk to someone else. Or simply move that collection account to the bottom of your list and go to the next one.

(5) Collection Account Settlement Tips

1. Stress:Settling a collection account can be stressful. If you are trying to settle a really small debt, just stop and pay it off in full. Save your energy for the big debts. 
2. Collection Account Removal: If you pay off a collection account in full, you should negotiate to have it removed from your credit report entirely. Each time that I have asked for this, it has been granted. This is really good for you because if you try to get a loan after that, whoever pulls your credit will have no idea that you ever had a collection account. 
3. Collection Account Non-Removal: If you settle a debt for less than the amount owed, you will probably not be able to have it removed from your credit report. This is generally a stipulation. The only way to have a collection account removed completely from your credit report is to pay it in full (once again this is in my personal experience as well as what I have seen as a banker).
4. Older Collection Account Settlement: The older the collection account, the easier it will be to settle it for less than what you owe. Think about it. If someone has owed you money for just a few months, there is a higher likelihood that they will pay you. But if they have owed you money for five or six years the chances of them repaying you are really low. This is why collection agencies are more likely to settle a collection account that is really old. You should be able to settle a debt that is three years or older for roughly 50% of the balance or so.
5. Non-Settleable Debts: There are some debts that you will not be able to settle no matter what. 
   1. The first one is IRS debt. If you owe money to the IRS for back taxes, they will not settle it. They will just throw you in prison instead. (Seriously, they have the power to do that.)
   2. The second one is federal student loan debt. Federal student loan debt is backed by the taxing authority of the US government. You cannot settle it or bankrupt it. There are only three ways to get rid of student loan debt:
      1. Pay pay it off in full.
      2. You become permanently disabled.
      3. You die.
6. Tax Implications of Collection Account Settlement: This one is important to remember. If you settle a debt for less than what you owe, you have to pay taxes on the settled amount as if it were earned income. The collection agency will send you a 1099-MISC at the beginning of the year and you must file it with your taxes. So for example, if you have a $10,000 debt that you settle for $4,000 you will get a 1099-MISC for $6,000. This means that you will have to pay taxes on the $6,000 settled amount. Don’t worry about it though. Paying taxes on $6,000 is a lot better than paying the entire $6,000 itself.

(6) Final Thoughts

Paying off collection accounts can be one of the most stressful financial situations of your life. But if you have made it through this entire article you are probably someone who wants to start cleaning up their financial mess! Kudos to you! I was once there as well. I spent about a year paying off collection accounts, bad debts, and old medical bills. 

It sucks. But like most things in life, the price is worth the reward.

You can do this! You are the hero of your story!

Until next time!