Aside from any moral or ethical decision involved in paying debt obligations, when it comes to a business decision, paying collection accounts may not be a financially sound one.
You may end up lowering your credit scores by paying old collection debt.
Let’s get this out the way first. In terms of any legal obligation, a debt is legally owed until it is paid, settled or discharged in bankruptcy.
A debt may remain on your credit report for up to 7 years but even after it drops off your report, a creditor can continue collection activities; even after a creditor charges off the debt. Your state’s statute of limitations will determine how long a creditor or collection agency has to file a lawsuit for an outstanding debt.
Once the statute of limitations has run, you can no longer be sued for the debt. But a creditor or collection agency can continue to pursue you for the debt even though they have no legal way of forcing you to pay up.
A charge off is basically an accounting term for a debt that is deemed uncollectible. Once a charge-off occurs it is removed from the creditor’s balance sheet. After the debt is removed from the books, a tax write-off is taken for the loss, and the debt is sold to a third-party collection agency for pennies on the dollar.
At this point the original creditor may not accept payment for the debt but instead direct you to the collection agency.
Paying a collection account will not improve your credit score, unless you get the account deleted from your credit reports. A “paid” or “settled” notation will not do anything to increase your credit score; it may even lower your scores. The following may cause you to think twice before paying a collection agency:
1. Most debt collectors will say anything to get you to pay and may promise to remove the debt from your credit reports but never follow through. It happens all the time. Consumers write me saying they were promised a removal if they paid right away, over the telephone, only to find out later the account was not removed.
If you do decide to pay a lump sum in exchange for a full deletion get everything in writing and conduct negotiations without ever acknowledging you owe the debt. Simply acknowledging you owe a debt, signing a written agreement to pay or making any type of payment is enough to restart the statute of limitations in some states.
2. You may negotiate a settlement for pennies on the dollar only to discover the collection agency sold the unpaid portion of the debt to another collection agency. The collection agency may even report the unpaid portion of the debt to the IRS, which in turn can tax the forgiven debt as income. Again, get everything in writing should you decide to negotiate a settlement.
3. Arranging to pay an old debt or making a lump sum payment in full (without getting a deletion) will update your credit reports and make the negative entry appear more recent than it is and your credit scores will take a dive. Recent negative activity is always more detrimental than older negative activity.
You may think it will not negatively affect you because the recent activity is actually a payment. Think twice. Without getting a deletion, paying off collection accounts registers as recent negative activity.
Debt collectors may attempt to make you feel as though you have committed a crime by not paying a debt but you have not. Whatever you decide when it comes to old debt is up to you but if the goal is to improve your credit score keep in mind the pitfalls when dealing with old debt, it may not be worth paying.