Debt collection is a stressful and overwhelming experience that millions face each year. It can be frustrating to receive repeated phone calls and letters from debt collectors, and it can be even more challenging to navigate finding the funds to repay when you have multiple debts hanging over your head.
Unfortunately, the consequences of unpaid debts can go beyond the immediate financial burden, impacting a person’s credit score and future financial prospects. In this blog, we’ll explore how debt collection can affect your credit score and what you can do to minimize the impact and get back on track toward a healthier financial future.
What Does It Mean When Your Account Goes Into Collections?
If a borrower misses a payment or pays late, the lender will typically send reminders through emails, letters, or phone calls to remind the borrower to make the payment. These reminders will continue until the payment is made or until a specific period has passed without payment.
If the lender cannot collect payment from the borrower, they may place the account with a collection agency. This typically happens after 90-120 days of delinquency.
- When an account goes into collections, it means that the lender has charged off the loan and has turned it over to a collection agency.
- The collection agency will then contact the borrower to request payment. They may use various methods to contact the borrower, including phone calls, letters, and emails.
- If the account remains unpaid for an extended period, the lender or collection agency may report the delinquent account to credit bureaus. This can negatively impact the borrower’s credit score and make it more difficult for them to obtain credit in the future.
What Happens to Your Credit Score When You Have Delinquent Accounts?
When you miss a loan or credit card payment, the creditor will typically report the delinquency. The delinquency will remain on your credit report for seven years, depending on the severity of the delinquency and your credit history.
Credit scoring models used in lending decisions assign higher importance to more recent delinquencies than older ones because those are considered more relevant indicators of a borrower’s risk of default. A borrower making timely payments for several months may be considered less risky than someone who stopped paying six months ago but has made regular payments since then.
It is important to note that even if the amount you owe is too small for a collection agency to pursue, your bank or credit union may still report the delinquent account. This can start a series of actions as follows:
Your Credit Score Gets Lowered
The most obvious thing that happens when you have debt is your credit score gets reduced.
A late or missed payment can lower your credit score by up to 100 points, depending on the severity of the delinquency and the length of time since the missed payment. According to FICO, the company that calculates credit scores, payment history makes up 35% of your FICO score, so even one late payment can have a significant impact.
Your Credit Options Become Limited
A lower score can impact your ability to obtain any other form of credit in the future, as lenders and creditors may view you as a high-risk borrower. This can make obtaining loans, credit cards, or mortgages more difficult and may result in higher interest rates or less favorable terms.
Your Interest Rates Will Be Hiked
Even if you can obtain credit with a lower credit score, you’ll end up paying higher interest rates and fees. This can result in paying more money over time, making it harder to pay off debts and get back on track financially.
For example, if you’re trying to take a loan to buy a new car, you’ll be subjected to a higher interest rate than someone with a high credit score. In fact, a recent study by Experian found that consumers with credit scores above 780 pay an average of 2.4% on new car loans, compared to 14.76% for those with scores less than 500.
High-interest rates can also make it more challenging to pay off debt and may lead to a cycle of debt and financial hardship. In addition, high-interest rates on credit cards and loans can make saving money and meeting other financial goals more difficult.
How Can You Improve Your Credit Score?
If your credit score is affected by your debt, you can do a few things to restore it:
Get organized: Start by gathering all your credit reports and reviewing your outstanding debts. List them in order of highest interest rate or balance owed.
Prioritize repayment: Begin by paying off the debts with the highest interest rates or balances first while making the minimum payments on other debts. This approach can help reduce the amount of interest you pay over time.
Set up payment plans: Contact your creditors and set up payment plans for any debts that you cannot pay in full. This will show creditors that you are taking steps to repay your debts and can help prevent further damage to your credit score.
If you have multiple debts, you can consolidate them into a single loan with a lower interest rate. This can make it easier to manage your debt and reduce your monthly payments.
Avoid opening new credit accounts: While working to pay off old debts, avoid opening new ones. This can negatively impact your credit score and make it harder to pay off your existing debts.
Pay bills on time: A single late payment can significantly impact your score, so try to make sure all payments are made by their due date each month. So make sure to pay all your bills on time, including credit card bills, rent, and utilities.
If you plan to improve your credit score and slowly pay off your debt, it’s best to contact the collector and devise a suitable repayment plan. At Capital Recovery, we work with the debtors and lenders to come up with a feasible repayment strategy that recovers the debt while helping the debtors regain their credit scores sooner.