If buying a home soon, handle old debt with care

How you settle with creditors could help your credit or hurt it


Credit Smart
Credit Smart columnist Susan C. Keating
Susan C. Keating is the president and chief executive officer of the National Foundation for Credit Counseling. Prior to joining the NFCC, Keating spent 29 years in financial services. She was the highest ranking female CEO of a U.S. bank holding company, serving as president and chief executive of Allfirst Financial Inc., the largest U.S. holding of AIB Group. She currently serves on Bank of America's National Consumer Advisory Council and is a board member of the Council on Accreditation. Keating also participates in the Financial Regulation Reform Collaborative, a nonpartisan group committed to finding solutions for reforming financial services regulation.

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Dear Credit Smart,
I have several accounts in collections from years ago when I was in college and in my early 20s. If I am looking to buy a home soon, what do I do about these debts? I have had several removed by disputing them, but there are a couple left. Should I pay them off? Or just wait a year for the seven-year mark to have them taken off my credit? Thanks! -- Caroline


Dear Caroline,
Buying a home is for most people the single largest purchase they will make. I suspect that is true for you, especially at this stage of your life. If you are ready to buy a home, I hope you have learned the lessons from your early years about taking care of your financial obligations on time. My answer to your question depends on how soon is soon for your home purchase. If you really only have one year left before these accounts fall off of your credit reports, it might be worth your while to just wait it out. But if soon means in the next few months, you will have to do something to pay them off now. 

It seems you have learned the importance of having good credit in homebuying. That's good. And taken steps to have old, negative items removed from your reports. That may or may not be good.

That's because you don't say whether the debts you disputed were removed because they were errors, or because you paid a credit repair company to dispute everything on your report. I hope it's the former. You have every right to dispute and remove debts that are not yours, or debts that have been in collections more than seven years. However, if they were more recent, legitimate debts, I have bad news for you: They will likely return to your credit report.

Credit bureaus must by law respond within 30 days to such requests. If they can't do it in time, they must remove the disputed item until they can verify it. In a process called credit report jamming, illegitimate credit repair operations will send multiple letters, disputing every debt on it. Because the credit bureaus can't verify every dispute in time, the ones they can't verify will be dropped from your credit report -- temporarily. As soon as they're verified, they'll be right back on it. If you've paid for this "service," you've been scammed, and you're further away than you thought from having a mortgage-qualifying credit score.

Because of that, I think you need to know exactly when these remaining items will be old enough to have them removed. You might consider holding off on your home loan purchase until that time if it works for you. It might also be wise to seek the help of a HUD-approved nonprofit housing counseling agency for some guidance regarding your available options and the timing of your decision.

However, if you are planning on moving forward with purchasing a home very soon, your best bet will be to pay them off in full, if you can. If not, and you are considering settling for less than the full balance, you will need to proceed with extreme caution. Under no circumstance do you want to have a notation on your report that states a debt was settled or paid partially. If you are offered a settlement that you are tempted to take, be sure to ask that your account be reported as paid in full and not paid partially or settled for less than the full balance. If you are able to come to a deal that you believe will work, be sure to get an agreement in writing that includes how the debt will be reported to the credit reporting agencies. 

No matter what you decide to do, you will not want these items on your report when it comes time to apply for a home loan. If you pay off the collection accounts, look at your reports to be certain they are reported as paid in full. Newer credit scoring models from FICO and VantageScore don't count paid collections. Likewise, if you decide to wait until the items have dropped off, be very sure that the items have been removed from all of your reports before you move forward. You want to be sure that your credit reports are in their best possible shape before you start applying for home loans.

Outstanding collection accounts will not look good to prospective lenders and might prevent you from getting the best deal. Even a few percentage points up or down in interest rates can make a huge difference in the life of a 15- or 30-year mortgage loan. By putting your best foot forward, you can save yourself a lot of money. This is one of those times to do everything you can to look your financial best.

Remember to always use your credit smarts!

See related: How partial payments affect your credit, legal rights, Don't expect big score boost when unpaid debt falls off credit report

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Published: March 26, 2016

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