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Your credit score is a three-digit number derived from a compilation of financial information. Companies like FICO, the top credit score provider, use data from your credit reports to calculate the number. FICO explains that 35 percent of your score is based on how well you repay your accounts, 30 percent is based on your total owed debt, 15 percent is based on the length of time you've had credit, 10 percent is based on your mix of different account types and 10 percent is based on how many new accounts you've opened. Collections accounts fall under your payment history, which has the largest effect.
Credit Score Effects
If you skip several months of payments on a credit card, loan or other account, the creditor will most likely send the matter to its collections department. This hurts your credit score because of the delinquent payments and the creditor's action. Other lenders will view you as a poor credit risk because you now have a history of not paying your bills. You will pay a high-interest premium on new accounts or you won't be able to open them at all because your poor credit score will peg you as a high-risk customer.
Collections can affect you beyond hurting your credit score. Collection departments can be aggressive, bombarding you with phone calls and letters demanding payment. The lender may decide to sue you and get a judgment against you for the debt. Depending on
your state of residence, the lender may be able to place a lien on your property or garnish your wages. The lender might opt to sell the account to an independent collection agency which may add fees that boost the total due.
You may be able to prevent creditors from sending your account into collections by contacting them as soon as you know you will have payment problems. Explain the situation and ask about potential solutions like reducing the monthly payment or changing the due date. Some lenders will refuse to work with you, but others may be open to assisting rather than having you potentially default on the debt.
You may hurt your credit score even more by paying off a collections account, Liz Pulliam Weston of MSN Money warns. A paid collection is still a negative item, and it looks even worse if you negotiate with the lender or collection agency and settle for a discounted amount. You will restart the statute of limitations on an old debt if you acknowledge it and make payment arrangements. Ask the creditor or collection agency for an agreement to report the debt as "paid as agreed" in exchange for paying it off. Insist on written confirmation before handing over any money so you can force the company to follow through, Melanie Sullivan of the Military Money website advises. This change will erase the effect on your credit report since there will be no evidence the account was ever in collections.