Struggling with debt?

If I Settle with a Collection Agency, Will It Hurt My Credit?

Understanding Collections and Your Credit Score

When you fall behind on paying your bills, creditors may eventually send your account to a third-party debt collection agency. This is known as having your debt go into “collections.”Collections can have a major negative impact on your credit score and remain on your credit report for up to 7 years from the date you first missed a payment. But what happens if you settle that debt with the collection agency? Will it still hurt your credit?The short answer is yes – settling a debt in collections will likely cause some damage to your credit score, at least in the short-term. However, the long-term impact depends on several factors. Let‘s dive deeper into how settling collections affects your credit.

The Credit Score Impact of Settling Collections

When you settle a debt with a collection agency, you are agreeing to pay a portion of the total amount owed as a lump sum or through a payment plan. In exchange, the collection agency considers the remaining balance forgiven and updates the account status to “settled” on your credit report.Having an account show as “settled” rather than “unpaid” is generally better for your credit score. However, it still indicates that you did not fully pay off the original debt as agreed, which is viewed negatively by scoring models.The exact impact on your credit score when settling depends on the credit scoring model used. For example:

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• Older FICO models like FICO 8 consider settled collections just as negative as unpaid collections
• Newer models like FICO 9 and 10 ignore paid/settled collections with a $0 balance
• VantageScore 3.0 and 4.0 also disregard paid/settled collections

So if a lender uses an older credit scoring model, settling could continue to ding your score for years until the collection falls off your report entirely. But with newer models, the impact may be minimal once the balance is updated to $0.It’s also important to note that larger collection balances tend to cause more credit score damage than smaller ones. Most models ignore collections under $100, and new credit bureau rules will soon remove paid medical collections under $500 from reports.

Pros and Cons of Settling Collections

Given the potential credit score impact, you may be wondering if it’s better to just pay collections in full or let them remain unpaid. Here are some key pros and cons to consider:Pros of Settling:

• Paying something is better than paying nothing from a credit perspective
• Settling gets the debt cleared and collection agency off your back
• You pay less than the full outstanding balance owed
• Newer scoring models may view settled accounts more favorably

Cons of Settling:

• Older scoring models still view settled accounts very negatively
• The settled status will remain on your credit report for 6-7 years
• You may have to pay taxes on any forgiven debt over $600
• Settling could restart the statute of limitations clock in some states

So in many cases, settling is the best option if you cannot afford to pay the collection in full. It helps resolve the debt and looks better than not paying at all. But it‘s not a perfect solution for your credit.

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Steps for Negotiating a Settlement

If you decide to pursue settling with a collection agency, follow these steps:

1. Request Debt Validation
   First, you’ll want to get all the details about the debt in writing from the collector. Under the Fair Debt Collection Practices Act (FDCPA), you can request debt validation within 30 days of being contacted. This requires the agency to provide evidence that you actually owe the debt.
2. Negotiate the Settlement Terms
   Once you validate the debt, you can start negotiating a settlement amount and payment terms. Collection agencies often purchase debts for pennies on the dollar, so they may accept 25-50% of what you owe.

Offer a realistic lump sum amount you can afford. If that‘s not possible, propose a payment plan you can stick to. Get any settlement agreement in writing before paying.

3. Request Removal from Credit Reports
   As part of the deal, you can try asking the collector to remove the collection account from your credit reports entirely after it is settled and paid. They may agree to this “pay for delete” in exchange for your payment.
4. Check Your Credit Report
   After settling, check your credit reports from all three bureaus (Experian, Equifax, TransUnion) to ensure the account was updated correctly to show settled with a $0 balance. Dispute any errors.
5. Start Rebuilding Your Credit
   With the settled collection behind you, focus on rebuilding your credit score through positive credit behaviors like making payments on time and keeping balances low.

While settling may cause a temporary credit score ding, the impact will lessen over time as you add positive information to your reports.

When Settling Isn’t an Option

In some cases, settling a debt in collections may not be possible or advisable. For example:

• The debt is too old and past the statute of limitations in your state
• You genuinely do not owe the debt and can prove it
• Bankruptcy may be a better solution for your overall debt situation

If you cannot settle and have a legitimate defense against the debt, you can respond to the debt collector‘s validation notice with a debt verification letter contesting the validity of the debt. This prevents the collector from continuing collection efforts on that debt.Alternatively, if your financial situation is dire, bankruptcy may allow you to discharge certain debts entirely and get a fresher start rebuilding your credit.

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Rebuilding Credit After Settling Collections

Even if settling causes an initial credit score drop, there are steps you can take to start rebuilding your credit over time:

• Make all future payments on time across all accounts
• Keep credit card balances low (below 30% utilization is best)
• Mix of credit types helps (installment loans, credit cards, etc.)
• Limit applying for new credit to avoid hard inquiries
• Use tools like Experian Boost to get credit for utility/telecom payments

The settled collection will remain on your reports for 6-7 years, but its impact will matter less and less as you add new positive payment history.

When to Consult a Credit Professional

Dealing with debt collectors and repairing your credit can be stressful and confusing. If you’re feeling overwhelmed, it may be wise to consult a credit repair professional or non-profit credit counseling agency.These experts can review your full financial situation, advise you on the best path forward for your goals, and negotiate with creditors on your behalf. Their assistance could be invaluable in getting you back on track.

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