Why Paying Off Debts Might Damage Your Credit Score

November 13, 2007 By Debbie Dragon

Paying the bills often hurts our wallets; but did you know paying the bills can also hurt your credit score sometimes?  Many consumers who have an account in collections, charge-off status or delinquency status on their credit reports find that their credit scores actually drop when they pay them off.

At one time in the recent past, it was possible to see your score drop by 100 points for paying off a delinquent account.  New FICO score calculation formulas prevents “new payments on old debts” being the ultimate cause for a scoring decrease, however, it’s still not safe to assume that paying off the older debt will result in a score improvement. 

Other issues that might arise and hurt your credit when you pay an older debt might include:

- Settling accounts for less than the total amount owed

- Setting up a payment plan

- Inquiring about an old debt may re-set the statute of limitations in certain states

- Inquiring about an old debt may rekindle interest from the creditor in attempting to collect the money

- Some unethical collection agencies may promise “fixing” your credit score if you pay on the debt, which may not happen.

It’s not secret that having an account in charge-off, collections or marked as “delinquent” on your credit score will impact your credit score negatively.  But did you know that it matters more to your score how the original lender shows your account than how the account appears on the report from collections?  In other words, if your original lender is showing the account as a ‘charge-off’ with the balance still owed, sometimes paying off the bill in it’s entirety can result in having that lender mark the account as “paid” and the balance as zero.  This should boost your credit score.

If the original lender shows the account as charged off with a zero balance- your chances of improving the situation are slim- and your score is not going to improve simply by paying the old debt.

Settling

Many people choose to pay a “structured settlement” on old debt through a structured settlement broker.  This typically means that the lender or structured settlement company agrees to accept a lower amount than the total amount due for the account.  While you may feel good that you’ve paid it off, the account is considered closed, and you saved some money the reality of the situation is it will appear on your credit report as a settlement; and that can hurt your score.

In addition, when you settle on an account and pay less than the original amount owed, you have to claim the difference as income on your tax returns that year.  So if you are able to pay half of what you borrowed to settle the account, the other half has to be claimed as income on your tax return that year.

Posted in credit score, debt

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