Lenders look at your credit report and credit score to see how creditworthy you are and to see if you can get new credit products like mortgages, credit cards, and auto loans. Your payment history is a big part of your credit score, so if you still owe money on old debts that are on your report, it could be hurting your score. Which brings up the question: Should you settle those old debts to boost your credit score? Read on to find out.
The Pros of Paying Off Old Debts
There are some potential benefits to paying off old debt that is still being reported on your credit report:
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It shows you are committed to paying your debts. When lenders review your credit report and see that you’ve paid off old debts it demonstrates you are making an effort to take care of your financial obligations even if they are very old. This could make you appear less risky.
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It may improve your credit utilization ratio. Your credit utilization ratio is how much credit you are using compared to how much you have available. Keeping this ratio low is important for your credit score. Paying off old debts can lower your overall utilization.
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It could positively impact your payment history. Payment history makes up 35% of your FICO credit score. Getting old debts paid off that had late payments could help this part of your credit score if you paid them off on time.
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You may qualify for better loan terms. Even if paying old debts doesn’t significantly improve your credit score some lenders do look deeper at your full credit report. Settling old debts that are still being reported could make you eligible for better interest rates or more favorable loan terms.
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No more collections calls. Finally clearing up old debts can stop debt collectors from continually pursuing you and contacting you for repayment. This can provide significant peace of mind.
The Cons of Paying Off Old Debts
However, there are also some potential drawbacks to consider when deciding whether to pay off old debt:
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The debts may be close to falling off your report. Most negative information falls off your credit report after 7 years. If your old debts are getting close to hitting that mark, you may want to just let them naturally fall off instead of paying them.
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It restarts the statute of limitations. The statute of limitations tells creditors how long they have to sue you for debts. Once you make a payment on a debt that is about to expire, the time limit starts over.
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There may be minimal score impact. Debts can remain on your credit report for 7 years, even after being paid off. And accounts that have been charged off by the lender will still show as “paid charge offs” even once settled. So paying them may not bump your score up significantly.
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You’ll have to cover the cost twice. If a debt is so old that it already negatively impacted your score for years, you’ll essentially have to pay for that credit mistake twice – once in the form of the initial score hit, and again when you actually pay off the debt.
Weighing the Pros and Cons
Whether paying off old debt makes sense depends on your specific financial situation. Here are some things to consider:
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How old are the debts? If they are very close to dropping off your report you may want to just let them.
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Will paying them off substantially improve your credit utilization ratio? If so, it may be worth it.
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Do you want to get rid of any late payments they have on file? If so, settling them could help.
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Is your credit score already in good shape? If so, paying old debts may not make much difference.
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Are collectors constantly hounding you? Getting them paid off may be worth it for peace of mind.
If you are unsure if paying off old collections and charge offs is the right move, consider speaking to a credit counselor. They can review your full credit profile and provide tailored advice based on your specific situation. A credit counselor can also help you negotiate with creditors and collectors to pay off debts in a strategic way that optimizes the benefits to your credit.
Other Ways to Improve Your Credit
Paying off old debt is just one potential step to take to boost your credit. Here are some other effective ways to improve your credit score over time:
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Pay all current bills on time. Payment history is very important, so staying current on all your existing credit accounts will benefit your score. Even just one late payment can drop your score.
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Keep credit card balances low. Having high balances close to your credit limits hurts your score. Keeping balances under 30% of your limits can help.
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Limit new credit applications. Each new credit application causes a hard inquiry on your report, which can ding your score a bit. Only apply for credit you need.
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Monitor your credit report. Check your credit reports from all three bureaus once a year for errors that could be depressing your scores and dispute any inaccuracies found.
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Build credit history. If you have limited credit history, consider becoming an authorized user on someone else’s credit card or taking out a credit builder loan to start establishing a payment record.
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Practice good credit habits. Using credit cards responsibly and maintaining healthy financial habits will help build your scores over time. Be patient as it takes perseverance to significantly improve credit.
By paying close attention to your credit profile and practicing good credit habits, you can rebuild and improve your credit scores without necessarily having to pay off old debt collections. Speak to one of our credit counselors to get personalized advice about the best ways to boost your credit.
How to Pay Off Debt
Choosing which debt to prioritize can be important, particularly when you want to quickly improve your credit scores. However, you can also strategize your approach to help you get out of debt sooner or pay less overall.
A General Guide to Which Debt to Pay Off First
Your credit scores depend on whats in your credit reports, and the impact of paying down or paying off a debt can vary depending on your situation. If your goal is to improve your scores, you might want to focus on the following factors:
- Past-due accounts: Getting open accounts that are past due back into good standing can minimize further damage to your credit scores.
- Collections: Paying off or settling collection accounts could improve some of your credit scores. Newer credit scoring models ignore paid-off collections accounts.
- Credit cards: If all your accounts are current, shift your focus to paying down credit card balances. Credit utilization is an important credit score factor that measures the amount of your available credit youre using. Even if you dont carry credit card debt from month to month, making early payments could decrease your reported balance and might help your credit scores.
- Installment loans: Paying off installment loans might help your scores, although there are times when paying off the loan will actually lead to a minor score drop instead.
Learn more: How to Improve Your Credit Score
Paying Collections – Dave Ramsey Rant
FAQ
Will paying off old debt improve credit score?
Yes, getting rid of old debt can help your credit score. How much it helps will depend on the type of debt and the credit scoring model used. For example, newer scoring models like FICO 9 and VantageScore 3. 0 and 4. 0 tend to disregard paid collections accounts when calculating your score, potentially leading to a score increase.
Does paying off debt increase credit score?
Yes, paying off debt can generally increase your credit score, but the impact can vary. Paying off or reducing your debt, especially accounts that are past due, revolving debt, and collection accounts, is a good way to improve your credit score.
Should I pay a 5 year old collection?
If you have a debt still within the statute of limitations, it’s generally in your best interest to pay it off so that you won’t have the long-term consequences of nonpayment on your credit.
Is it better to pay off old debt?
If you want to get a mortgage, car loan, or other big loan, paying off debts that are in collections can help your chances of getting approved. Lenders scrutinize your credit report and collections accounts can be red flags indicating financial instability.