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Will Paying Off Delinquent Debts Improve My Credit Score?

One of the most common questions I get from consumers is whether or not paying or settling defaulted debts will improve their credit reports and credit scores. Normally, this question applies to charged-off credit cards, deficiency balances on auto loans after repossession, unpaid collections, tax liens and defaulted student loans. Each of those liabilities can be paid off after the fact, or the balance can be exhausted via an offer in compromise (i.e. a settlement).

Accurate Credit Reporting Is Step One

Once the item has been paid or settled the next step is to ensure that it is reflected accordingly on your credit reports. In a perfect credit reporting world, the account would be updated within 30 days to show the new balance. However, we don’t live in a perfect credit reporting world. As such, it might be necessary to dispute the item with the credit bureaus so that they can do their research, find that it has been paid, and update your credit reports. All in, this process will likely only take a few weeks. The good news is that you can provide documentation proving that the item has been paid, such as a receipt or a letter from the collector, which should help expedite the process.

The Impact of Paying Delinquent Debt on Your Credit Scores

Now that the item has been updated, your credit scores should improve, right?  In the past the answer would have been, “It’s not that simple.” At one time all commercially available versions of both the FICO and VantageScore credit scores cared much less about the balances on your delinquent accounts and much more about the fact that the account went delinquent in the first place. The incident is what mattered—not so much the balance of the incident. This is still true for older versions of their credit scores.

However, in the newest versions of the FICO and VantageScore credit scores paying or settling your delinquent debts, specifically those that were in collections, can result in a higher credit score. This underscores the importance of actually working with debt collectors to exhaust your balances rather than avoiding or ignoring them, which is a strategy that some experts actually will suggest.

Settling and Paying Means the Same Thing, Sort Of

In FICO and VantageScore’s newest models, collections that have a zero balance are ignored. That’s a considerable departure from how they considered zero dollar collections in the past. So your goal now is clearly to get your collections to show a zero balance on your credit reports. How you get your collection to a zero balance is your choice, but settling them is going to save you a ton of money and yield the same credit score result.

Both paying a collection in full and settling a collection are going to result in the same balance, zero dollars. Settling the debt, however, is going to save you hundreds or thousands of dollars. In fact, collectors are very open to the idea of agreeing on settlements with some of them even offering seasonal “specials” on settlement discounts to coincide, for example, with tax refund season.

So How Will My Score Change?

If you are able to pay or settle a delinquent collection, and you apply with a lender that’s using a newer credit scoring system, there’s a possibility that your scores are going to be higher than if the collection still had a balance. Keep in mind, however, that your score may not change at all, especially if you’ve got other negative information on your credit report. The extent to which your scores will improve may be as little as a few points, or as much as several dozen points. You can check your free credit score right here at Credit Sesame. It’s the VantageScore 3.0 model, which is one of the scoring systems that ignores zero dollar collections.

What About Other Delinquent Debts?

Obviously collections don’t represent the entire universe of possible delinquent debts. You can be delinquent on your mortgage, your credit cards, your student loans and your car loans without any of them being in collections. Paying those to a zero balance is not going to cause FICO and VantageScore to ignore them so the likelihood that your scores will improve is much less. You may earn a few points because scoring systems do consider balances on delinquent accounts, but it’s not as influential to your scores as the fact that you are delinquent.

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