How to handle collections on credit reports
Do you have collections on your credit report and you’re not sure how to improve your credit score?
A question comes in from someone who had three collections and they were unsure how to improve their credit score. As always any time consumers pay off a collection accounts the reporting date will be updated on that collection to today. That course of actions is going to hurt their credit score depending on how old that collection was and what scoring model they are trying to improve (more on that here). Updating the reporting date on a collection can really negatively impact the credit score.
A short-term strategy for improving credit scores should never be to pay off collections. A short-term strategy for improving consumer’s credit scores is to pay down debt on revolving accounts and paying everything on time. That’s the only short-term strategy that will work with the current scoring model that Fannie and Freddie require. Paying off a collection depending on the reporting date is never a good idea. Let’s say the consumer had a longer term time horizon, let’s say they had a year. If they want to improve their score over a year then they would want to approach the creditor and offer a settlement of the debt for whatever they’re comfortable with. I usually say if 10% is good enough for the Lord then start with 10% with a collection company.
The negotiation will probably wind up at 50% of the original debt. Then settle it quickly after they get the agreement in writing. If the consumer can negotiate a pay for delete agreement that’s great! I would always start with an attempt to get the collection company to agree to remove the collection. If they’re not interested in doing that then consumers are still better off just settling the debt and closing it out. Having the date reported sunset as time goes by is best for a consumers credit score.
It really comes back to what is their credit goal if their goal is to have good credit in the future, a year or two out then paying off collections is a good strategy. If they have already put in an offer on a house then it is too late. Paying off a collection is not what they should be doing. It could keep would be home buyers, home renters. Be very cautious, contact a mortgage professional before making any moves on collections or watch more videos at the Credit Guy TV
That’s how you handle collections, very cautiously.
One note about debt forgiveness.
I had a good friend of mine actually have a large amount of debt forgiven. When that happens the IRS looks at that as income, many times consumer can get an income tax bill for the amount forgiven. If a large amount of debt is forgiven it’s very likely that that consumer is going to have to pay income tax on that the following year.
How to handle collections on credit report
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