Collections: How It Affects Your Credit

Collections affects credit

In part one of this series we discussed how you get sent to collections and what their process is. For part two we will look at why collections are an important factor in your credit score. As well as how being sent to collections affects your ability to get many types of credit in the future.

Understanding Collections Items

An item being sent to collections will almost always be reported on both of your Credit Reports – Equifax and TransUnion. Your reports have an area titled “Collections” where this will be listed.

Each collections item will show the following:

  • An agency or creditor name; or both if a collections agency has the file and is reporting the item
  • The outstanding balance
  • Any important comments on your file
  • The date of when your file went to collections

A collections item will remain on your Credit Report for at least 6 years from the date it is first reported; even when fully paid. Despite remaining on your report, paying the outstanding balance is still crucial to be considered for credit in the future. Once paid, the item will be “closed” or completed and creditors (banks, lenders, etc.) will be pleased to see you were able to pay outstanding balances.

When a debt is sent to collections, the agency will attempt to get payment from the consumer. However, if they are unsuccessful, the debt can be assigned, or sold, to another agency for an additional period of time. In this case, the items often remain “open” for many years beyond the 6 years previously mentioned. They don’t necessarily “automatically fall off” your Report as many people believe.

The Affect on Your Credit

Collections items play 2 major roles in determining a consumer’s credit “worthiness.”

When it comes to lenders, some have a zero tolerance policy when it comes to collections. Any amount in collections will result in a loan application being automatically denied. However, other lenders may be more lenient; a small cell phone or utility item at a few hundred dollars or less, may be ignored. In this case, your application would be continue on to be evaluated.

Where lenders almost always say no is when your collections report is from another financial institution. Old credit card and banking fees aren’t usually ignored, but especially not previous lender fees. They will be extremely hesitant to fund an applicant if they have failed to pay back one of their competitors.

Think of it this way – two friends came to you a year ago asking to borrow $100. You lend both friends the same amount, but a year later only one of them has paid you back. Those two friends come to you again – who are you willing to lend more money to? Probably the one who paid you back last time!

The second major stumbling block for collections items are that they will lower your credit score. The more items you have, and the higher your collections balance gets, the more it affects your credit score. Your score will be lower than it needs to be if you had simply paid off the amount owing. Knowing that lenders are most concerned with credit scores, a lower score drastically decreases your chances of loan approval.

In part three of this series, we will discuss your rights. As well as some negotiating tips and tricks to help you when dealing with collections agencies.

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