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When to pay off old debt

On a few occasions, it's best to repay ancient loans (carefully)

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Years ago there was a bill that you couldn't or wouldn't pay. Now your finances have turned the corner or you have forgotten about your beef with the creditor.  You could ignore it, but ...

There are solid reasons to pay old debts -- even ones that are too old for court -- in order to improve your credit, end collection hassles or even boost your career.  But move carefully, or you could wind up with a fresh headache.

"On paying old debts, there are actually a lot of things to think about," says Becky House, communications and education director at American Financial Solutions.

The main reason to pay is to bolster your credit profile. A delinquent debt can appear on your credit report long after it is time-barred under the statute of limitations, meaning you don't have to worry about being sued over it.

When is it OK to pay old debt?

In some states, debts are too old to be brought into court as soon as three years after the delinquency, and most states' statute of limitations run for six years or fewer.  But the black mark remains on your credit report for seven years, regardless of the debt's legal status.  (The one exception to the seven-year rule is for New York State residents, whose demerits disappear just five years after the delinquency, if they pay the charge-off amount or satisfy a court judgment.)

"Getting rid of those debts on your report is definitely in your best interest," says Natalie Lohrenz, director of counseling at the Consumer Credit Counseling Service of Orange County (Calif.) "When (a debt) gets to a collection agency, the original creditor has given up, which is a danger sign to lenders."

Repaying the old debt will not erase the original delinquency from your credit report, but it should improve your creditworthiness in the eyes of lenders -- assuming you can afford to pay it without getting behind on other bills. Paying can be particularly important if you are getting ready to buy a car, refinance a loan or apply for a home mortgage.

"When you're applying for a loan that is rate sensitive, for example, it might make a few points difference in your interest rate if you pay off your time-barred debts," says Maxine Sweet, vice president of public education at Experian, one of the three major credit reporting bureaus.

Unpaid debt weighs on your credit score most heavily when it is freshest and makes less of a dent as time goes on. Paying off a debt in collections won't provide a big, immediate boost to your FICO score. However, other scoring formulas view you more favorably for paying the delinquent debt. And lenders who review your entire credit file, not just the score, may take a dim view of someone who has neglected to clear up old debts before applying for new credit.

"Scores aren't everything in the lending decision," says Rod Griffin, director of public education at Experian.

Even if you're not thinking about applying for a loan, a black mark on your credit record can hurt you in other ways. Unpaid debt can flash warning signals at potential employers, some of whom look at credit reports during the screening process for new hires.

"If you're applying for a position where you would handle money, make over a certain amount of income or have to pass a security clearance -- these are times when you might consider paying a time-barred debt," says House. Even people applying for temporary retail jobs have run into snags because of demerits on their report, she said.

Perhaps as important as your credit record -- if not more so -- is your peace of mind. Collectors can continue to make calls, even for a debt that is beyond the statute of limitations, using the argument that your moral obligation to pay has not expired just because your legal obligation has. As long as the calls are not harassing or otherwise violate debt collection laws, they can continue indefinitely.

"They can call you 20 years later," said Lohrenz. "If that would cause you enough grief to make it worth paying it off, then it's worth paying it."

Payoff strategy
If you do decide to pay off a time-barred debt, it just makes sense to protect yourself from pitfalls that could create new problems.

If you are paying in order to improve your credit profile, be aware that settling the debt for less than the full amount will be recorded differently on your credit report than payment in full. Just how negatively a particular lender will view that is difficult to know. But if your goal is to show that you have tried to fully live up to your obligations, paying less than the initial charge-off amount won't do it.

After paying, follow up by checking your credit report from the three major credit reporting agencies to see that the new status of the account is reflected accurately. After making the payment, wait 30 to 45 days before requesting copies of your credit reports to ensure that the collector and the credit bureau have had time to update their records, Griffin says.

Checking to make sure the figures are correct is another important step.

"If someone contacts you saying you owe money, don't ignore the letter and don't pay the money until you get the documentation that proves you owe it," says Lauren Willis, a professor at Loyola Law School.

Regulatory reports have found significant paperwork problems with debts that have been sold on the debt market -- which describes most older debts that are in collections. Under the federal Fair Debt Collection Practices Act you are entitled to verification of the debt in writing.

If you are paying just to end collection calls, consider negotiating a settlement for less than the charge-off amount. If your sense of honor allows you to erase the debt at a discount, your wallet will thank you. Older debt is typically sold for pennies on the dollar -- the average price was only about 4 cents for each dollar in debt, the Federal Trade Commission found in a study. That means  the company behind the collection calls probably bought the right to collect your account for a small fraction of the balance that was charged off years earlier. If the debt is beyond the statute of limitations, you have a strong bargaining position to push for a deep discount.

Before agreeing to pay, ask for a copy of the contract that covers the sale of your debt to the collector, as well as a written payoff agreement. That documentation, along with your canceled check or credit card statement showing that you paid, will be important to have on hand if demands for payment surface again, possibly from a different collector.

"Part of the problem with these (time-barred) accounts is that you pay it off," says Willis, "and then they sell it to another debt collector who will then come after you."

See related: Don't pay dubious debt without proof

Published: April 1, 2013


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