If you have ever been on the receiving end of calls from a debt collector, you will know well the anxiety that comes with an account in collections. No one wants a credit account to be passed off to a collection agency, but it happens often to those experiencing financial difficulties that make it challenging to cover their monthly payments on time.
When a borrower defaults on a loan or stops making their credit card payments, lenders and credit card issuers will sell the debt to a collection agency, so they don’t have to deal with the hassle of getting payment. This is not only done for loans and credit card balances but also for landlords, utility companies, and medical service providers.
If you are looking to improve your credit score after a collection account, a good place to start is to gain a clearer understanding of the credit scoring system. From there, you can better know how collection accounts impact your credit and what you can do to obtain a good credit score.
What Information Is on Credit Reports?
Your credit report is of enormous importance in many different areas of your life. Credit reports are not only relied upon by mortgage lenders and credit card companies but can also be instrumental in apartment applications, insurance coverage, and even employment opportunities.
The information on your file is compiled by three major credit reporting agencies – TransUnion, Experian, and Equifax. All details and facts are either reported to or gathered by the credit bureau to portray an overall view of your creditworthiness as a borrower. Each credit bureau generally divides the information into the categories of personally-identifying details, credit accounts, credit inquiries, public records, and collection debts.
Personal details like your full name, date of birth, Social Security number, current and previous addresses, and employment information are included in your credit report to connect you to it. Next, your report will have details on all your credit accounts, including the type of account (i.e., personal loan, credit card, online fast cash loans, mortgage loan), the date the account was opened, the loan amount or credit limit, available credit, and payment history.
Whenever you authorize a credit check, a new hard inquiry will appear in the credit inquiries section of your credit report. Soft inquiries from pre-approval and checking your own credit are included there as well, but they do not impact your credit score. And finally, public records like bankruptcy and foreclosures, as well as collection accounts will show up as derogatory marks on your credit report.
How Credit Scores Are Calculated
The information on credit reports is then used to calculate three-digit credit scores to give a more broad view of an individual’s creditworthiness at a glance. There are many different credit scoring models, but the most widely used is undoubtedly the model created by the Fair Isaac Corporation.
FICO scores are calculated by dividing up an individual’s credit report into five parts, each part with a different percentage in the calculation. The calculation of the FICO scoring model is as follows:
Payment History – 35%
Your payment history is the most important aspect of your credit history when it comes to determining your credit score. It’s for this reason that most financial experts will advise borrowers to always make their payments on time to improve their credit scores.
All on-time debt payments boost the integrity of a borrower’s payment history, making a positive impact on their credit score. All missed, or late payments harm an individual’s credit score and are to be avoided.
Amounts Owed – 30%
The amount you owe on all your credit accounts makes up 30% of your credit score’s calculation. Having too much debt can be a problem, especially if it causes you to have a high credit utilization ratio.
Your credit utilization ratio is the amount of debt you owe in credit card balances compared to the total available credit you have on your credit limits. Keeping low balances is better for higher credit scores. Most financial experts recommended a credit utilization rate of 30% or lower.
Length of Credit History – 15%
The length of your credit history in the calculation of your score takes into account the average age of your credit overall. The age of your oldest and newest credit account will inform on how established your credit history is on the whole.
New Credit – 10%
All newly opened credit accounts and hard inquiries are worth 10% of your score’s total calculation. Even though soft inquiries like pre-approval and checking your own credit are included on your report, they are not used in the calculation of credit scores. Too many hard inquiries and new accounts opened in a short period of time can lead to lower scores.
Credit Mix – 10%
When it comes to credit mix, the various credit scoring models want there to be some variety in the types of credit accounts borrowers have. Having five to ten different accounts, all utilizing the same account type, will not impress creditors. A wider variety and different types of credit is far preferable.
Credit Score Classifications
The classification of credit scores according to the Fair Isaac Corporation are as follows:
300-579 → Poor
A credit score between 300 and 579 points is considered poor credit. It is incredibly challenging to get approved for new credit at all when you have a poor credit rating in this range. And those lending products that are available, like loans for people with poor credit, tend to have extremely high-interest rates making them difficult to afford.
580-669 → Fair
A credit score between 580 and 669 points is considered fair credit. With a fair credit score, you might be able to access a few more opportunities, but you will still likely be charged higher interest rates than your peers with a good credit score.
670-739 → Good
A credit score between 670 and 739 points is considered good credit. Having a good credit score means you are more likely to receive pre-approval offers from lenders, banks, and credit card companies. You will likely be able to get approval for credit products with market-equivalent rates.
740-799 → Very Good
A credit score between 740 and 799 points is considered very good credit. A credit score within this range will give you access to far more competitive interest rates. A very good credit score can get you better offers and make denial less likely.
800-850 → Excellent
A credit score between 800 and 850 points is considered excellent credit. There is a wealth of opportunities open to you with an excellent credit score. You are the borrower that companies want to worth with. Because of this, you will have access to the most competitive interest rates and best deals available.
Is a 700 Credit Score Possible With Collection Accounts?
It is theoretically possible to get a 700 credit score with a collection account on your credit report. However, it is not common with traditional scoring models. A derogatory mark like a collection account on your credit report can make it incredibly difficult to obtain a good credit score like 700 or over.
How Long Do Collections Remain on Your Credit Report?
Collection accounts are almost always reported to the credit bureaus and, according to the Fair Credit Reporting Act (FCRA), can remain on an individual’s credit report for up to seven years from the date of the original debt’s first delinquency.
Can Paying off Collections Improve Your Score?
Newer credit scoring models do not include collection accounts that have a zero balance, meaning that when you pay off your balance, you should see your credit score increase. That being said, older models still factor in collection accounts even if they have been paid off. Some lenders still use the older scoring models, especially mortgage lenders, so it is important to be aware either could be used.
Improving Your Credit Score After Collections
If you have recently had a collection account on your credit report, there are plenty of things you can do to improve your credit score. A 700 credit score may not be too difficult to reach if you have paid off your collection account and you are using one of the newer credit scoring models. However, if you want to play a more active role in boosting your credit score, there are several strategies you can employ to get the results you want to see.
Here are a few of the most important things to keep in mind when rebuilding your credit after a collection account:
Prevent a New Collection Account
To ensure that your credit recovers quickly, do whatever you can to prevent any new collections from being created for debts you have. This will mean that you need to be very careful not to have any late payments in your payment history. Late payments have the potential to harm your credit, but not handling the required payments can also lead the lender or credit card issuer to sell the remaining balance to debt collectors. A secondary collection account will not only stall your efforts to improve your score but also lead to bad credit that is even harder to fix.
Handle all your minimum payments for your credit cards and monthly installments on your loans by the due date or earlier to make a positive impact on your credit. If you have a habit of forgetting to make your payments, we recommend setting up automatic payments so that you won’t ever miss a due date again. You will thank yourself for making the change when you see the difference in your credit score.
Lower Your Credit Utilization
One of the most reliable ways to give your credit score a major boost is to lower your credit utilization ratio. If you are approaching your credit limit on all your credit cards, you likely do not have much available credit and a very high utilization ratio. Paying down the balance of your credit cards until you have 70% of your total credit limit is available credit will significantly improve your credit score.
By doing this, you will make your minimum payments more affordable and decrease the financial stress your credit card debt causes in your life. As a general rule for responsible credit usage, always keep your credit utilization rate at 30% or below. Additionally, you want a reasonable debt-to-income ratio to keep your finances as low-stress as possible.
Stop Applying for New Credit
After you’ve paid collections, take a break from applying for any new credit. All applications for new credit, whether that’s for credit cards or loans, will create a new hard inquiry on your report. Too many hard inquiries within a short period of time can result in bad credit, so it’s a good idea to take some time off so that your credit has time to recover.
It may take some time to see the results of your efforts, as credit scores don’t jump a hundred points overnight. Patience is crucial to building credit after a derogatory mark like collections. The time and effort you put into it are well worth it because of the financial opportunities that will be available to you with good credit.