If you have a low credit score and are working towards raising it, it seems to make sense to pay off all of your old delinquent debts. However, this strategy can sometimes backfire and drop your score further. Any credit score repair strategy should involve analyzing each debt and predicting how changes to it will affect your overall score. (For more on what can affect your credit score, check out The 5 Biggest Factors That Affect Your Credit.)

TUTORIAL: Credit and Debt Management

Although the exact formula used by FICO is proprietary and not publicly-disclosed, it is estimated that approximately 35% of the score relates to your payment history and 30% to the amount you currently owe. Paying off old debt will not erase the impact that previous delinquent payments have already had on your credit score. Depending on the status of the debt, making payments on or paying off a charged-off debt can hurt in the currently-owed category.

Paying off a Delinquent Account
If a credit account is simply overdue and shows as outstanding debt, paying it off will improve your credit score, as will making any payments against it. You will not be able to eradicate the late payments that are showing, but returning the debt to current status and reducing the overall amount owed will both boost up the number.

Paying off a Charge-off
This is where payments can actually reduce your credit score rather than improve it. If you have an old debt on your credit report that has been charged off by the lender - meaning that they do not expect further payments - setting up a new payment plan can re-activate the debt and make it appear to be more current than it actually is. This is often the case with debt that has been turned over to a collection agency. The agency may register the debt with credit bureaus as new rather than reporting it against the written-off debt. As newer debt weighs more heavily on your credit report than older debt, your score can drop when you make an effort to pay this type of debt. This can also occur with paying out the debt entirely. While the payment will make the debt show as settled in full, it may show on your report as new debt. Regardless of how it shows on your report, ensure that the lender removes the charge-off status on your old debt and shows it as paid in full. (To help you cut your debt, read Expert Tips For Cutting Credit Card Debt.)

Settlements
If you choose to settle with a lender for less than the total owed, the arrangement will show on your credit report and may drop your score depending on how it is reported. Some lenders will simply mark it as paid, which has a positive affect on your score; however, if they show it as settled, your score may suffer. Although you can ask a lender how they will report the settlement while you are in negotiations with them, you ultimately have no control over how they will report it.

Payment Strategies
If you must juggle repayments of old debt, start with those debts that are still showing as delinquent. That will give you the biggest boost in the short-term. Carefully review older debt that shows as charged off. Before contacting the creditor or collection agency, check your state laws to see if the debt is statute-barred, meaning that it is too old for creditors to attempt further collection. If it is not statute-barred, even contacting the creditor can re-instate the debt as currently collectible, which can drop your score.

If the debt is due to drop off of your report in the next several months because it is almost seven years old, consider waiting until then to pay it, as it will have no affect on your score once it drops off. If the debt shows as written off but will still show on your credit report for longer than a few months, collect all of the funds together to completely pay it off before making contact with the lender. That way, you will potentially re-activate the debt but will also show payment in full which will minimize the damage to your score. (For more information on creditors and collection agencies, check out Outfox The Debt Collector's Hounds.)

The Bottom Line
The best strategy in managing your credit score is to pay your obligations on time, every time. If you do get behind, though, how you manage your old outstanding debt can have a significant impact, either negatively or positively, on your score. (To learn more, read A Lifeline For Those Drowning In Debt.)

Related Articles
  1. Economics

    Explaining Cost Control

    For a business, cost control entails managing and reducing expenses.
  2. Economics

    What Happens in a Default?

    Borrowers are in default when they don’t honor a debt, whether their failure is intentional or not.
  3. Credit & Loans

    Millennials Guide: Buying Your First House

    Millennial homebuyers need to research a lot of things, such as how much to pay, down payments, PMI, FHA loans and special programs for first-time buyers.
  4. Insurance

    5 Ways to Lower Life Insurance Premiums

    Learn several effective methods for lowering life insurance premiums. These include quitting smoking and considering term life insurance.
  5. Budgeting

    The 7 Best Ways to Get Out of Debt

    Obtain information on how to put together and execute a plan to get out of debt, including the various steps and methods people use to become debt-free.
  6. Credit & Loans

    Don't Get Burned by High Credit Card Rates

    The average card charges 11.8%, and some rates top 20%. Experts warn that credit card interest may remain steep.
  7. Credit & Loans

    Refinance Vs. Debt Restructuring: What's Best For Your Credit Score?

    Discover key differences between refinancing and restructuring debt in regard to terms, the negotiation process and effect on credit scores.
  8. Credit & Loans

    Guidelines for FHA Reverse Mortgages

    FHA guidelines protect borrowers from major mistakes, prevent lenders from taking advantage of borrowers and encourage lenders to offer reverse mortgages.
  9. Savings

    How Volatile Exchange Rates Affect Your Vacation

    Those ever-changing fluctuations can make a difference in anything from your hotel room to an ATM transaction.
  10. Credit & Loans

    Can Corporate Credit Cards Affect Your Credit?

    Corporate cards have a hidden downside. If the company fails to pay its bills, you could be liable for the amount and end up with a damaged credit rating.
RELATED TERMS
  1. Cost Accounting

    A type of accounting process that aims to capture a company's ...
  2. Credit Rating

    An assessment of the credit worthiness of a borrower in general ...
  3. Internal Rate Of Return - IRR

    A metric used in capital budgeting measuring the profitability ...
  4. Transferable Points Programs

    With transferable points programs, customers earn points by using ...
  5. Regional Asset Liquidation Agreement ...

    An agreement between an asset manager and the Federal Deposit ...
  6. The New Deal

    A series of domestic programs designed to help the United States ...
RELATED FAQS
  1. Why would someone change their Social Security number?

    In general, the Social Security Administration, or SSA, does not encourage citizens to change their Social Security numbers, ... Read Full Answer >>
  2. How does a bank determine what my discretionary income is when making a loan decision?

    Discretionary income is the money left over from your gross income each month after taking out taxes and paying for necessities. ... Read Full Answer >>
  3. What is the range of deductibles offered with various health insurance plans?

    A wide range of possible deductibles are available with health insurance plans, starting as low as a few hundred dollars ... Read Full Answer >>
  4. How do I know how much of my income should be discretionary?

    While there is no hard rule for how much of a person's income should be discretionary, Inc. magazine points out that it would ... Read Full Answer >>
  5. Do negative externalities affect financial markets?

    In economics, a negative externality happens when a decision maker does not pay all the costs for his actions. Economists ... Read Full Answer >>
  6. What is the difference between disposable and discretionary income?

    According to the Bureau of Economic Analysis, or BEA, disposable income is the amount of money an individual takes home after ... Read Full Answer >>

You May Also Like

Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!