Will My Credit Score Improve If I Pay Off a Derogatory Account?

Yes, paying off a derogatory account can potentially improve your credit score, particularly for certain types of accounts and credit scoring models that differentiate between paid and unpaid negative entries. While the derogatory mark itself will remain on your credit report for a specific period (typically seven years from the date of the first delinquency), updating its status from "unpaid" to "paid" can be viewed more favorably by lenders and specific scoring algorithms.

How Paying Off Collections Can Help Your Score

For some of the latest credit scoring models, such as FICO® Score 9, FICO Score 10, VantageScore® 3.0, and VantageScore 4.0, there is a distinct difference in how unpaid collection accounts are treated compared to paid ones. These models are designed to penalize unpaid collection accounts more severely. Therefore, by paying off these collection accounts, you may see an improvement in your scores calculated by these more modern models. This distinction acknowledges that you've fulfilled your obligation, even if it was late.

Consider this example: If you have an unpaid medical collection for $200 on your report, FICO Score 9 might view this more negatively than if that same collection account were marked as "paid in full." While the record of the collection remains, its severity in the scoring algorithm's eyes is reduced once paid.

Understanding Different Types of Derogatory Accounts

The impact of paying off a derogatory account largely depends on the specific type of negative mark on your credit report.

1. Collection Accounts

• Definition: An account that has been sold or assigned to a third-party collection agency because you failed to pay the original creditor.
• Impact of Paying Off: As mentioned, paying off collection accounts is beneficial, especially with newer scoring models. It changes the status from unpaid to paid, which is seen as less risky by some lenders. However, the collection itself will still appear on your report for up to seven years.
• Strategy: When dealing with collection agencies, consider negotiating a "pay-for-delete" (where the agency agrees to remove the account from your credit report upon payment, though this is rare and not guaranteed), or at least ensure they report the account as "paid in full" or "settled." Get any agreement in writing.

2. Charge-Offs

• Definition: An account that the original creditor has written off as a loss after a period of non-payment. Unlike collections, charge-offs are usually still owned by the original creditor or sold to a debt buyer.
• Impact of Paying Off: Paying off a charge-off will change its status on your credit report from "charged-off" to "paid charge-off" or "settled." This looks much better to prospective lenders than an unpaid charge-off, indicating you've resolved the debt. However, the derogatory nature of the charge-off itself remains on your report for seven years.

3. Late Payments

• Definition: Payments made beyond the due date, typically 30, 60, 90, or more days late.
• Impact of Paying Off: Once a late payment is reported, paying off the current balance or bringing the account current will not remove the past late payment history. The record of the late payment will remain on your credit report for seven years from the original delinquency date. However, bringing the account current stops further late payments from accruing and prevents the account from potentially going to collections or being charged off.

4. Bankruptcies and Foreclosures

• Definition: Legal processes that involve the inability to repay debts (bankruptcy) or the repossession of property due to unpaid mortgage (foreclosure).
• Impact of Paying Off: These are severe public records that remain on your credit report for 7 to 10 years (depending on the type of bankruptcy). Paying off associated debts after these events have occurred does not remove the public record. Time and responsible credit habits post-event are the primary factors for score improvement.

Why Credit Score Improvement Isn't Always Instant or Guaranteed

While paying off derogatory accounts is a positive step, the immediate impact on your credit score can vary due to several factors:

• Credit Scoring Model Used: As discussed, older FICO models (like FICO Score 8, still widely used) may not differentiate as much between paid and unpaid collections, or may give less weight to the "paid" status.
• Age of Derogatory Mark: The older a derogatory mark, the less impact it generally has on your score. A paid collection from two years ago might help more than a paid collection from six years ago.
• Overall Credit Profile: Your credit score is influenced by many factors, including your payment history, credit utilization, length of credit history, new credit, and credit mix. If you have multiple derogatory marks or high credit utilization, paying off one account might not lead to a dramatic score increase immediately.
• Reporting Accuracy: Ensure the creditor or collection agency accurately updates the account status on your credit report after payment. Monitor your reports closely.

Practical Steps to Address Derogatory Accounts

If you have derogatory accounts, here's a general approach:

1. Obtain Your Credit Reports: Get free copies of your credit reports from AnnualCreditReport.com to identify all derogatory accounts.
2. Verify the Debt: Ensure the debt is legitimate and accurate. If not, dispute it with the credit bureaus.
3. Prioritize High-Impact Accounts: Focus on collection accounts or charge-offs that are more recent, as these typically have a greater impact on your score.
4. Negotiate Payment: Contact the creditor or collection agency to negotiate a payment.
   • Lump Sum: Offer a lump sum payment for a reduced amount (often 50-70% of the original debt).
   • Payment Plan: If a lump sum isn't feasible, negotiate a payment plan.
   • Get It in Writing: Always get the agreed-upon terms, including the payment amount, timeline, and how the account will be reported to credit bureaus (e.g., "paid in full"), in writing before making any payment.
5. Monitor Your Credit Report: After payment, regularly check your credit reports from Experian, Equifax, and TransUnion to ensure the account status is updated correctly to "paid" or "settled."

By proactively addressing derogatory accounts, you not only improve your credit report's appearance but also demonstrate financial responsibility, which is crucial for long-term credit health.

For more information on managing your credit and understanding your score, you can visit reputable sources like:

• Experian
• Equifax
• TransUnion
• Consumer Financial Protection Bureau (CFPB)