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.
Medical collections, unpaid student loans, and more, can unfortunately remain on your credit history for up to seven years. So if you’re looking to improve your credit report or FICO score, you want to avoid collection accounts at all costs.
Collection 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 agency who 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 who 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 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 up to seven years. 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:
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 affects credit scores. Banks and financial institutions may be wary if they see someone as the owners of too many debt accounts.
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 bills, personal 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. You should also be wary of working with suspicious lenders who offer astronomically high loan amounts with little to no requirements. Scam lenders like this could be connected to the dark web and leave you with nothing but stress, debt, and a potential account with a debt collector.
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 know what types of loans and debts you can reasonably afford. Luckily, there are safe and affordable installment loan options for borrowers with poor credit.