It is vital to note that this particular strategy for credit improvement is not going to work for everyone. If you are currently sitting at a FICO score over 620, with only a few past due debts, settling them may hurt you more than help you in the long run. However, for individuals with credit scores dipping below 620, debt settlement might be just what the doctor ordered, especially for debts less than $1,000.
Let’s get the grim news out of the way first. Repaying any charged off debt or collection account is going to reset the clock on that debt, allowing it to stay on your credit report longer. When a payment is recorded to collection accounts, the status of that account updates to “new” account status. Settling any old debt means a short-term decline in credit scores. However, the payment of the debt reduces consumer overall debt to income ratios, resulting in positive credit after about six months.
It gets better
When approaching a collection agency correctly with a debt settlement offer, the agency agrees to release you from liability on all amounts in excess of the settlement agreement.
For example, John had an account from Dr. Meyer’s office that went into default. After default, Dr. Meyer’s office turned the defaulted debt over to collection for $600 two years ago. John sends the collection agency a debt settlement offer. In the offer, he agrees to pay $300 in exchange for the collection agency to identify the account as paid in full on all three of this credit reports, and stipulating that the agency agrees not to attempt recovery of the additional $300 using any other means. The company accepts John’s offer, finally sending a signed copy of the agreement back to John. John makes the payment, clearing his bill and releasing him from any further obligation for additional charges, fees or interest.
What this looks like to the credit bureaus
Perhaps one of the most attractive things about debt settlement is that credit bureaus are none the wiser when it comes to the discounted settlement amount. The debt previously reported on John’s credit report, now shows as “paid in full” after the $300 settlement, but the $300 never comes in to play. As far as credit bureaus and credit providers are concerned, the debt of $600 was paid in full, removing $600 from John’s overall debt to income ratio. That decrease of overall debt is the catalyst for a FICO score increase.
When to settle
Since collection accounts are reported on credit histories for seven years starting from the day of charge off, debts under five years old are available for settlement without too much of a negative credit reporting impact. In order to find out exactly how old an account is, order your free three-bureau credit report. Visit www.annualcreditreport.com to order. Then, look for the “payment history” for each account listed on the report. The date of charged off or sale to a collection agency is the most noteworthy. Use that information to determine if a resolution is worth it. Debts over 4 years old are usually better off “disappearing” from a credit report after the 7-year marker, rather than settling.
More from this Contributor:
Stop! Before You Pay that Old Debt, Read This First
The Truth About Credit Repair
Collection Agencies and the Rinse and Repeat Strategy