This monthly series by personal finance specialist Amanda Reaume focuses on how to improve something that many people overlook: your credit score. These posts will give you tips and tricks to improve your chances of getting approved for better rates when you apply for credit – leading to better student loans, car loans and even mortgages.
The last thing anyone wants is to be so behind on repaying debt that they end up in collections.
When your account goes to a collections agency, it likely means that that you’ve failed to pay bills and you were unable to set up or stick to a new repayment schedule. Usually, this happens between three and six months after you first default on your debt, and it can definitely impact your credit score, and subsequently, your future finances.
If your account goes into collections, it’s usually because you’re facing extreme financial difficulties. It can be scary and stressful, but there is a way out.
Why is my credit score affected by being in collections?
Your credit score is a crucial factor that banks and other lenders consider before they lend you any money. Having a low score can impact your ability to be approved for a mortgage, a student loan or financing for a car, and you’ll likely have to pay a higher interest rate on the money you borrow.
Being put in collections can devastate your score because over 35 per cent of your score is calculated based on your repayment history. Another 30 per cent is calculated based on the amount you still owe and how much credit you’ve used. For example, if you’re using over 20 to 30 per cent of your available credit, you’ll lose points because your credit utilization ratio is not in the ideal range.
How can I improve my credit score and get out of collections?
This may sound obvious, but the best way to get out of this type of situation is to face it head on and pay off all of your debt. Bad credit stays on your credit report for seven years, but lenders may be more willing to approve you and give you better interest rates in the future if you can show that you’ve paid off your collections debt completely.
The sooner, the better, and there are ways to lessen your overall debt and the impact:
Negotiate with the collections agency
If you have the means – contact the collections agency or the lender and ask if they would be willing to erase the collections record in return for immediate payment in full. Some lenders and collection agencies are willing to make this type of agreement.
If you’re not able to pay off your debt anytime soon, many people opt to negotiate a settlement in which you and the lender come to an agreement where you pay a lesser amount. The trouble with choosing this option is that the settlement will also be added to your credit history and that will reduce your credit score even more.
If mitigating circumstances contributed to why you were unable to pay your debt, such as illness, losing your job, or another personal tragedy, they may also be willing to schedule a payment plan and delete the record once the debt is paid.
However, remember that collections agencies are under no obligation to make any sort of agreement with you and that this is only a possibility.
Start Rebuilding Your Credit
Once you have done all you can to repay your debt and remove the collections record from your credit history, it’s important to apply for new credit and use it responsibly.
Doing this will help you rebuild your score, but it takes a long time to reverse the damage to your credit, so you should start immediately after paying off your debt. It could take over six months to a year of on-time payments before your credit score starts to improve.
If you’re not able to qualify for a credit card because of the current state of your credit score, consider getting a secured credit card. With this type of card, you have to put down a deposit before you get approved. For example, you would be required to provide a $500 deposit to get a card with a $500 limit. After you’ve rebuilt your credit score with a secured card, you should be able to qualify for a regular credit card.
Even if you failed to get the collections record removed from your credit history, don’t despair. Still, it’s important to repay all of your debt and start making smart credit decisions to rebuild. Pay your bills on time (set up small weekly automatic payments if you’re prone to forgetting!), and don’t use too much of your available credit on any particular credit card.
Your credit score will likely bounce back significantly after seven years. when the collections record is removed from your credit history.
While rebuilding your credit score from the bottom seems like a long journey – it’s worth it.