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How much does collections affect credit score?

How Much Do Collections Affect Credit Scores

Medical collections, unpaid student loans, and other collection accounts can, unfortunately remain on your credit history for up to seven years and significantly negatively hurt your score. So if you’re looking to improve your credit report or FICO score, you want to avoid collection accounts at all costs. An estimated 1 in 3 Americans have a debt in collections.1

Dealing with collection debts and wondering how much it could affect your credit score? When a loan borrower fails to pay back their lender, they may send the borrower’s debt information to a collections account. A major credit bureau can then view that delinquent pay history and take note of it for future credit reports and credit scores.

Collection companies/agencies are under the control of the Consumer Financial Protection Bureau. This U.S. government agency is in charge of ensuring that banks, lenders, and other companies that provide financial services treat people fairly. In other words, an original creditor cannot refer to a debt collector unless a borrower has made absolutely no effort to rectify their delinquent pay history. 

What Is a Collection Account?

A collections account is an account with a collections agency made when a creditor reports unpaid debts. Suppose a bank or financial institution hasn’t received payment from a debtor in a while. In that case, they may send their contact information and other account data to a collection bureau which will then try to rectify the past-due accounts. Understanding what a debt collector is and how they work may help you to avoid them in the future.

Sometimes, third-party debt collectors cannot work with the debtor to make reasonable efforts toward paying off their loan. In that case, the collection agency may label the account as a charge-off. Charge-offs occur when a debt collections agency writes an account off as a loss. In the instance of a charge-off, the collection agency will send the collection account information to a debt buyer. A debt buyer is a company that buys charge-off accounts from debt collectors who were unable to receive payment. 

How Will It Affect a Credit Score?

If your collection accounts are getting out of hand and you want to avoid legal action, a last resort may be to declare bankruptcy. When someone claims that they are bankrupt, they admit that their financial accounts have a zero balance, disabling them from taking care of their expenses and debt. 

But how much can a collection account affect credit scores? The answer is, unfortunately, quite a bit. If a single collection account is the only negative item on your credit report, your score can still take a significant hit. 

Why do collection accounts have such a significant impact on credit scores? According to newer credit scoring models, payment history is one of the most critical factors the three major credit bureaus look at when determining a credit score. And since collection accounts are directly related to poor payment history, they have a major impact on someone’s credit report. 

After a borrower has paid collections and taken care of their debt collector accounts, the delinquent payments will remain in their report for around seven years—usually up to that time. Do your best to stay on top of your debt payments to your original lender to avoid your FICO credit score taking a hit because of a collection account. 

Credit Scoring Models and Credit Reports 

A credit scoring model is how the major credit bureaus organize personal information to determine someone’s credit score. Periodically, credit bureaus will collect personal data about someone’s finances and use it to develop a three-digit number meant to represent that person’s creditworthiness

Both newer and older scoring models include positive and negative information in the data for credit reports. Major credit reporting agencies then use that data to determine a credit score. Equifax, Experian, and TransUnion are the three main agencies that produce credit reports. It’s important to be familiar with them and to know what credit score you need to get a loan.

These agencies use a standard credit scoring model consisting of 5 main factors when determining credit scores: 

Credit Scoring FactorsDescription
1. History of Payment– How you make payments on your credit accounts.
2. Amount of Debt To Pay– The total amount of debt, including collections, contributes to the credit report.
– High levels of debt can result in a different credit score compared to those with low or zero balances.
3. Length of Credit History– The duration of active credit accounts influences the credit report.
4. Types of Credit– The variety of credit accounts held can impact credit scores.
5. New Credit– Newer credit scoring models consider the types of credit accounts.
– Each application for new credit involves a hard credit check, which can affect the credit. 

Continue reading to learn more about each factor:

History of Payment 

When a debtor has successfully paid collections and made every payment on time, this behavior can positively affect credit reports. If your last payment was late, this delinquency can, unfortunately, remain on your credit report for up to seven years. 

Amount of Debt To Pay 

The amount of collections that remain in your account, or your overall debt, also contributes to your credit report. If an applicant has much debt, they may have a different FICO score than someone with zero balance for all their debts. 

Length of Credit History 

How long someone has had various credit accounts also affects a credit report. The longer someone has had active financial accounts, the more their credit report will benefit. 

Types of Credit 

The varying forms from which debtors collect payment also affect credit scores. Banks and financial institutions may be wary if they see someone as the owner of too many debt accounts. 

New Credit 

According to newer credit scoring models, types of credit can also contribute to a credit report. Every time you apply for new credit, your lender will run a hard credit check that can end up affecting your credit score. To keep new credit from affecting credit scores too much, try to keep the number of times you apply for loans to a minimum. 

To ensure the truthfulness of an Equifax credit report, make sure you always provide accurate information to all financial institutions. 

Why Does Collections Affect My Credit Score Altogether? 

Looking at an Equifax credit report, data that has the biggest effect on a credit score is whether you make payments on time. So if someone has a collections account, this indicates to a creditor or lender that the person has trouble keeping up with their promised loan installments. 

Any unpaid debt like student loans, medical debt, personal loan options, payday loans, credit card debt, and more can hurt credit. The more late payments someone has accumulated, the more their credit score will suffer. 

Furthermore, working with a collection agency also dictates to credit bureaus that a borrower has accumulated debt. Since amounts owed are also a major contributing factor to someone’s credit report, accounts with debt collectors can significantly reduce credit scores. Suppose a lender finds out that a loan applicant has been referred to a debt buyer in the past. In that case, they may immediately reject them for funding for their own financial protection. 

Never get a loan without a payment plan to avoid making a late payment and potentially getting a collections account that could affect your credit. 

How Often Should I Check My Credit Report? 

To make sure you are on top of your debt and aren’t affected by a collections account, you should check your FICO score often. But be careful that you are performing a soft credit check and not a hard credit check. 

A soft credit check is essentially a free consultation of your financial history and does not affect your overall FICO score. Credit cards or other financial products will often have a feature where you can see your credit score and receive a free copy of your credit report

A hard credit check, on the other hand, can affect credit. Before lenders grant approval, they run a hard credit check to confirm their applicant was truthful about their information and aren’t going through pre-bankruptcy consultations. Since these hard credit checks are typically tied to receiving new credit, they can affect your credit reports. 

While collections accounts can significantly affect your credit report, they can also be avoided by having a solid payment plan for your debts. Never accept a loan with terms or rates that you can’t afford to pay, and you should be able to steer clear of a debt buyer or debt collector.

Avoiding a debt collector means knowing what types of loans and debts you can reasonably afford. Luckily, there are safe and affordable installment loans for borrowers with poor credit.

FAQS

What triggers a debt to be sent to a debt collector?

When a borrower consistently fails to make payments on their debt, the original creditor may decide to send the account to a debt collector after a certain period of delinquency, typically 60-180 days.

How can I remove a collections account from my credit reports?

If the collections account on your credit reports is inaccurate or outdated, you can dispute it with the credit reporting agency. If the account is valid, you can negotiate a “pay-for-delete” agreement with the debt collector, where they remove the account in exchange for payment. However, not all debt collectors agree to this.

Does paying off a collection debt improve my credit score?

Paying off a collection debt can prevent further damage, but the account’s presence will still negatively affect your credit score. Over time, its impact will lessen, especially as it ages and as you add positive information to your credit reports.

What’s the difference between the original creditor and debt collector?

The original creditor is the entity that initially provided the loan or credit. If the debt goes unpaid, they might sell or assign the debt to debt collectors, who will then attempt to recover the amount owed.

How can I negotiate with debt collectors under the fair debt collection practices?

Start by verifying the debt and understanding your rights under the Fair Debt Collection Practices Act. Then, communicate in writing and consider making a settlement offer. Always get any agreement in writing and be aware of your rights when dealing with debt collectors.

If I settle a medical debt for less than the full amount, how is it reported on my credit report?

If you settle a medical debt for less than the full amount, the credit reporting agency will typically mark the account as “settled” or “paid settled.” While this is better than an unpaid collection debt, it’s still a negative mark.

Does ignoring paid collections on my credit reports affect my credit score?

Yes, even if you ignore paid collections on your credit reports, they can still negatively affect your credit score. It’s essential to address any collections, paid or unpaid, to ensure the best possible credit score.

Conclusion With CreditNinja

In conclusion, the impact of collections on one’s credit score is profound and long-lasting. When borrowers default on their loans, their debts can be transferred to collection agencies, which can then be reported to major credit bureaus. Such negative marks can linger on credit reports for up to seven years, significantly affecting one’s FICO score. 

The Consumer Financial Protection Bureau oversees collection agencies, ensuring fair treatment of consumers. It’s crucial for individuals to understand the distinction between original creditors and debt collectors, as well as the implications of charge-offs. 

The severity of a collection account’s impact on credit scores is largely due to the emphasis credit scoring models place on payment history. CreditNinja wants you to know that to maintain a healthy credit score; you should regularly monitor your credit reports, be wary of suspicious lenders, and strive to avoid collections by making your payments on time.

References:

  1. 1 in 3 U.S. adults have ‘debt in collections’ | CNN Money
  2. Collection Accounts and Your Credit Score | Equifax
  3. Homepage | ConsumerFinance.Gov 

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