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There are lots of reasons to improve your credit score. If you want to buy a new car or get a home loan or refinance your existing mortgage, you’ll get a preferable interest rate with a higher credit score. If you’re hoping for a new job that requires good credit or a security clearance, that’s another reason to better your score. But one thing you might not know is that, in some cases, paying down debt can hurt your credit score. Here’s why.
Paying Off an Installment Loan Can Drop Your Credit Score
Many factors play a role in your credit score calculation. One of them is types of credit. Suppose you have one installment loan, such as a car loan, and the rest of your accounts are credit cards. Paying off your installment loan changes your mix of credit accounts to less diverse, and this can drop your score a bit.
Also, an installment loan benefits your credit less over time which may sound strange. However, it offers a greater benefit earlier in the life of the loan, and your score can drop slightly when you pay it off because it’s no longer actively factoring into your credit score on a monthly basis as a positive and open credit account because it closes once you’re done.
What this means is that if it won’t affect your budget or do other adverse damage, paying off an installment loan early may not be a good idea. If you will see significant savings by paying it off early, that makes sense. But if it’s a wash on your finances and there’s nothing to be gained from paying it off sooner, it may benefit your score to keep paying as planned and not accelerate payoff.
Paying Off a Collection Item Can Worsen Your Score
If you have a collection item on your credit report, you might hope that if you pay off the item, the debt collection firm will remove it as a negative item. However, a debt collector is under no obligation to remove an item from your credit report. Instead, after you pay it off, all they legally must do is report that it’s at zero balance due.
Although it seems like paying off the debt should raise your score, in fact, it could drop it. That’s because activity on a collection account can be interpreted by the scoring algorithm as a bad thing. The smarter approach is to negotiate with the original creditor if you can. For instance, if it’s a VISA account, talk to the card issuer and ask if you can pay them.
If you pay off the original creditor, the debt collector has no right to report to the credit bureaus. If you must work with the debt collection firm, negotiate a payoff that includes them removing the item from your credit score. You should ask for the agreement in writing before you pay them and record conversations with the firm.
North Carolina is a “one party consent” state, meaning you can record your personal phone calls without the consent of the other party. Once you pay, follow up to ensure they remove the item from your credit report as promised. But without an agreement and assurance first, the collection agency is not obligated to remove the item even though you paid.
Paying Off an Older Item Close to Aging Off of Your Report
It’s important to know the delinquency dates of your debt in collections so you can avoid making a big mistake by paying an older item just before its status is set to change. The first date to know is the statute of limitations. In North Carolina, most debt has a three-year statute. What this means is that from the date you stop paying the debt, the legal enforceability expires in three years.
For instance, if you have a VISA card and stopped using the card and stopped paying it in January 2014, that is when the statute of limitations clock started ticking. It’s from the date of last activity which means a payment by you or a charge by you on the card. In January 2017, if you didn’t use the card again or make any further payment, the statute of limitations expires.
That means the card issuer or a collection agency they sold the debt to cannot sue you after that three years. They can still ask you to pay, but it’s voluntary. The problem is that if you decide to pay the debt, it can restart the statute. The second date to know is when it drops off your credit report. That comes seven years after the last activity.
If the creditor can convince you to pay them even $5, it’s a trick to get the statute and credit reporting limits to start over again. So, before you pay any old debt, educate yourself on the ticking time limits for legal enforceability and credit reporting or else you could damage your credit score for years to come with an ill-timed mistake.
If you’re rebuilding your credit score after bankruptcy, Credit Score Keys is here to help. Call us at 919-495-2365 today for a free consultation.