Pay the whole debt or pay part: Which helps credit score more?


Dear Let's Talk Credit,
My husband and I went through a rough patch a few years ago, and several charge accounts were "charged off" and then ultimately sold to a collection agency. We want to improve our credit now that we are back on our feet. We would like to start paying off some of these collections. Which will improve our credit score more: Paying the entire amount owed to the agency (which is often much more than the original debt) or making (and paying) a settlement? -- Jenny


Dear Jay,
I'm glad to hear you and your husband are in a better financial situation and able to begin paying off your old debt. Unfortunately, your credit was damaged when the accounts were charged off due to nonpayment. This will continue to be a negative on your credit history until they are removed from your credit report, usually after seven years. The good news is that the more time has passed since the accounts were charged off, the less negative impact the accounts have on your credit score.

You are wise to pay the charged-off accounts, even though doing so will not cause a substantial increase in your credit score. Depending on how old the accounts are and how much you owe, the collectors may decide to use the courts to collect. The collector could be awarded a debt judgment, which could mean a wage garnishment order or bank account levy in your future. Better to be proactive and work out a payment solution before the courts are involved.

Before the accounts are removed, any future creditors will want to see that you paid the accounts either in full, or for an agreed-upon settled amount. Paying in full will look much better to potential lenders. However, what you decide to do should be based on your current ability to pay, rather than how it might improve your credit.

Before contacting creditors, you need to know how much you can pay either in a lump sum or through monthly payments.

In addition, you may want to find out if the collector is willing to work with you on a payment solution. Should you decide you want to settle the accounts for less than the full amount, you might consider contacting an attorney who is experienced in handling collection accounts for consumers.

Always get everything in writing, ahead of time. You do not want a different collection agency attempting to collect the amount that was not paid in the settlement agreement. Another thing to keep in mind when settling an account is that the forgiven debt is considered income to the IRS and you will have to pay taxes on the forgiven amount.

Let's keep talking!

See related: What wage garnishment is, and how to avoid it

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Updated: 01-22-2018