Everything You Need To Know About Collection Accounts - And More!

By: Shonnie Fischer - CreditCRM Affilaite

Of all of the questions I get regarding consumer credit reporting and credit scoring, collection account inquiries seems to be at the top of the list on a daily basis. This months newsletter is dedicated to the subject of collection accounts and what affect they have on a consumers credit report. Additionally, the most prevalent “credit myths” associated with collection accounts will also be addressed in this article. Far too often myth vs. fact gets passed onto the consumer which in most cases causes further undue damage to the consumers credit report and scores respectively.

Most consumers have a general understanding of what a collection account is. By definition, a collection account occurs if you stop paying on any type of debt where a balance is owed and remains unpaid per the terms of the original agreement contractually entered into by the consumer and financial entity. The lender then takes action to collect on the unpaid and/or deficiency balance by transferring the status of the account from a routine account to a collection account. The lender may have an internal collection department that will then take over the account to collect on, or the lender may sell or assign your account to a outside third party collection agency. Either way the bottom line and single objective is to collect on the remaining debt owed.

Pretty basic so far.....

Collection agencies specialize in collecting money from people who refuse to pay their debt. A collection agency’s main leverage over a consumer, which is also the single most important motivational tactic they use to get a consumer to pay, is by reporting the collection account to the credit bureaus. Any collection activity that reports to the credit bureaus will hurt your FICO® scores. Even if it is a single collection account that reports, you can expect a significant drop in your credit scores once it hits the credit bureaus. As you can imagine, having multiple collection accounts will cause your credit score to plummet even further as you are adding multiple layers of major derogatory information a.k.a “risk” to your credit file.

With respect to the FICO® credit scoring system, collection accounts are considered a major derogatory “event”. When a collection account is reported, the FICO® credit scoring software considers two things and two things only when factoring in a collection account into the credit scoring system. The first factor is that collection account activity exists and is a part of your credit file, which as previously stated is considered a major derogatory account. The second factor is the age of the account relative to the date of original delinquency with the original creditor that lead to the collection account having to be established in the first place. Specifically, this particular credit scoring component as explained is the perfect segue into our first two (and most prevalent) credit myths.

Myth #1- Paying Off A Collection Account Will Increase A Consumers Credit Score.

This is absolutely false!! If you pay off a collection account, typically the effect on the credit score will be neutral. If your scores do increase it will not be by much - guaranteed! Whether or not a collection is reported as paid or unpaid is NOT a credit scoring component. What the FICO® credit scoring system factors in is the fact that you went to collection in the first place. As stated above collection accounts are scored as “events” with the only other credit scoring factor being the age of the account. Collection accounts regardless of the paid vs. unpaid status are indicative of your previous payment history and therefore used as a predictive measure of future credit risk as assessed in the credit scoring software.

The Fair Isaac Corporation, the creators of the FICO® credit scoring software have this information posted on their website myfico.com under the following link: http://www.myfico.com/CreditEducation/Questions/Collections.aspx.

Myth #2- Paying Off Collection Accounts Will Remove It From Your Credit File.

Again, totally false. Unfortunately this where most consumers make an incorrect assumption only to find the account still remains on their report the next time their credit gets pulled. Paying off a collection account will not cause or force automatic removal from your credit report. What will happen once the account is paid, is the balance is updated to reflect the account has been paid in full and the account will continue to report accordingly. Collection accounts whether paid or unpaid along with derogatory information outside of public records, can report for up to 7 years based upon the date of original delinquency with the original creditor. Prevalent with lending and/or industry professionals, the next myth we will address is not so much a consumer credit myth as it is one that is more common with lending specific and/or industry professionals who work with analyzing consumer credit.

Myth #3- Paying Off Collection Accounts Does Not Lower A Consumers Credit Score.

In all fairness, this is a current myth that is based on a past truth. So those of you reading this article who knew this to be the case in days past, let me confirm you are not losing your mind. In previous credit scoring models (still commercially available as late as 2008) when a collection account was paid off it would update the date of last activity which in turn would report into the credit scoring software as if it were a brand new collection account. The date of last activity used to be a credit scoring component in the FICO® credit scoring software, however in 2007 the Fair Isaac Corporation agreed with debt collectors
that a consumer should not be penalized for paying off old debt accounts. While it is true that any current activity causes the date of last activity to reset, FICO® has revised their scoring software to only consider the date of original delinquency for scoring purposes.

To further validate that this is in fact a current truth vs. future feature to come, in September 2009 John Ulzheimer, credit scoring and credit reporting expert and author who is also the President of Consumer Education for Credit.com, went straight to the source and interviewed Ethan Dornhelm, Principal Scientist at FICO® who is also a FICO® score developer to get further clarity on this subject. Mr. Dornhelm confirmed that “The FICO® score is focused on the presence of the collection and how recently the collection occurred. This is true at all credit bureaus and across all generations of the FICO® scoring models still
commercially available today.”

So now that we have covered what a collection account is, what impact it has on a consumers credit score, as well as the most prevalent credit myths associated with collection accounts, what is the best way to handle collection accounts or recover from the adverse affect they have on a consumers credit report?

1- The most obvious answer is to avoid them all together. Pay your bills on time and if ever you find yourself in a financially distressed situation, try to work out a payment plan with the creditor prior to them having to take further collection
action. Be proactive and be honest about your situation with creditors. This is not always going to be an across the board resolve, but at least it lets the creditor know that your are not intentionally disregarding your obligation to pay them. They may or may not do a work out plan with you, however it is worth the effort to contact them first vs. having them assume the worst case which will without question be to start immediate collection action against you to collect on the money owed to them.

2- If number one can not be avoided and an account has already gone into collection, work with the collection agency and try to negotiate deletion of the account in exchange for payment. Not every collection agency will negotiate these types of terms, however I can tell you from my own personal experience that four out of five will. Collection agencies work on commission and/or a consignment fee basis, so at the end of the day they are truly only interested in collecting on the debt and typically will negotiate for deletion when payment in full is received. For consumers this is well worth doing the leg work to try and negotiate this type of agreement with them as this is THE ONLY way to get a valid collection account completely removed from your credit report.

3- If you have a collection account that you do not agree with, or do not believe belongs to you, you do have rights under the Fair Debt Collections Practices Act to dispute the debt. Ignoring the debt or otherwise refusing to pay the collection agency to punish them for what you perceive to be their error is not the way to get this resolved. This type of action will only continue to hurt you as collection agencies are famous for selling debt multiple times over if uncollectible. Each time that happens it adds additional new collection activity to your credit report causing a layer effect. You do have rights under the Fair Debt Collections
Practices Act that allow you to properly and legally dispute the validity of a collection account reporting on your credit report. A summary of your rights is available on the RE Credit Repair website under the Credit Resources section link: http://www.recreditfix.com/credit_resources.php I hope you have enjoyed this publication and it has provided you some clarification and/or helped you to better understand collection accounts in general. Trust me - speaking from personal experience this is one of the most complex areas outside of credit scoring itself to master. If you have any further questions or need personal assistance regarding collection accounts or any other credit related matter please contact me direct via email or my office line anytime.

All my best to you and thank you for reading this months publication.