Credit Scores and Collection Accounts
Collection accounts will almost always have a significant negative impact on a credit score.
A collection account is a listing in a credit report that represents a consumer account that has been assigned to a company to collect on an unpaid debt obligation.
If a consumer stops making the contractual payments on an account or debt, the lender or creditor may assign the account or sell the account to a collection agency. This action turns a credit account into a collection account. The collection account is the account with the collection company that is collecting on an unpaid consumer debt and is generally not the original creditor or original lender.
The original unpaid obligation or debt may be from a credit card debt that was unpaid, medical bills, utility bills, or any other contractual debt that was left unpaid and then sent to a collection agency by the original creditor. The collection account is the account with the collection agency as opposed to the delinquent account that exists with the original creditor.
The original creditor’s delinquent account may also be reflected in the credit report. For instance, a collection account for an unpaid credit card balance may be reported to the credit reporting agencies as the original delinquent account with the credit card company, usually as a charged off account, as well as the balance now being collected by the collection agency.
A collection account may also be reflected in the credit report without a corresponding original creditor account. As an example; cell phone companies and medical bills that are unpaid may be sent to a collection agency to collect the unpaid delinquent debt and these creditors will not report to the credit reporting agencies, yet the collection agency the debt is assigned to will most likely report to the credit bureaus or credit reporting agencies.
A credit score evaluates collection accounts on an individual’s credit report according to when the collection occurred. Individual credit scores weigh collections on a credit report according to when the collection occurred. Generally, the more recent the collection, the more it’s going to impact the credit score.
Collection account records, no matter how recently opened, all should expire and be removed from an individual’s credit report seven years after the last 180-day late payment on the original debt.
Note that closing an account doesn’t make the record in the credit report go away. A closed account will still show up on a credit report, and its status will be considered in the credit score calculation. Paid collections and unpaid collections are generally scored the same; the impairment to a credit score occurs as a result of the account being delinquent. .
Since the collection account is different from the original creditor account, whether it is a credit card or a medical bill, and the collection accounts cannot report a payment history since technically there is no payment record with collection agency only with the original creditor then there will not be a payment history from the collection agency in the credit report and the credit score simply evaluates the date of the account and the amount.
It is always worth the effort to investigate the validity of collection accounts and the amount owed to see if they can be removed from a credit report for inaccuracy, which is common.
Will a Debt Consolidation Loan Help My Credit Score?
A: Debt consolidation loans are one of many alternatives to help improve an individual’s financial position. Debt consolidation loans can reduce a number of monthly debt payments into one consolidated payment that will usually have a much lower monthly payment. The debt consolidation can certainly reduce monthly payments and reduce stress but the impact on credit scores will generally be fairly small shortly after the loan. Over time a debt consolidation loan can improve a credit score more significantly.
The main factors that are used to calculate a credit score include: payment history, amount of debt owed, length of credit history, new credit and types of credit used. Based on this information, a reasonable conclusion is that the credit score will not change since none of these factors are technically altered. The amount of debt an individual has remains the same, the debt is just moved on to one account from several accounts. And though any accounts that may have been late in the past are now paid off and consolidated into one loan, those payment histories will still remain in the credit report.
The factor used in credit score models that does improve, is a subset of the amount owed. Measuring the amount owed on an individual’s credit report to determine a credit score evaluates several aspects of the accounts including the total amount owed on accounts, the amount owing on specific types of accounts, the number of accounts with balances, the proportion of credit lines used or the proportion of balances on revolving credit accounts such as credit cards to the total credit limit, and the proportion of installment loan amounts still due or the proportion of installment loan balances to the original loan amount.
One of the factors that changes with a consolidation loan, mentioned in the list above, is credit utilization or the total balances in relation to the available credit. Since the new consolidation loan pays off a number of other balances on credit cards and other accounts that are included in the new consolidation loan, those accounts will now experience a measurable increase in available credit. The new loan doesn’t change the amount of debt; it simply increases the total available credit with the new loan amount and reduces balances on more than one account that were paid off with the new loan. Over time this will increase the credit score.
Since the component of the credit score that will be impacted the most by the consolidation loan is the amount of credit available, which has become available due to the new consolidation loan, these accounts should not be closed. If the accounts are closed after they are paid off, this will reduce the amount of credit available, thus lowering the credit score.
Overall, it can be very difficult to say how any one single factor or new information will impact a credit score because the value of each factor depends on the overall information in the credit report. The credit score is dependent on the mix of information, which varies from person to person and for any one person over time.
Credit Scores and Credit Limit Changes
Credit scores are influenced and change up and down to a number of attributes found in an individual’s credit report. The FICO credit score is the most common credit score used by lenders. In calculating credit scores, the FICO score is derived by analyzing the data in an individual’s credit report and will change as the credit report data changes.
A number of factors are weighed in a credit report to come up with the credit score. Factors include length of credit, payment history, amounts owed, amount of new credit, types of credit used and other factors.
One of the other factors used to determine the credit score is the amount of available credit in relation to credit outstanding. This is further analyzed by the proportion of credit lines used or the proportion of credit line balances such as credit card balances in relation to the total credit limits on certain types of revolving accounts. The FICO score considers the consumer’s credit limit to evaluate what is referred to as the credit utilization rate or how much available credit is being used at the time the score is calculated. The greater an individual’s credit utilization rate, the greater the risk that person will eventually default on a credit account.
Therefore it is reasonable to find two individuals that have fairly similar credit histories and payment patterns and one of these individuals has incurred a significant amount of credit card debt in relation to their available credit limits, while the other individual has relatively low credit card balances in relation to the available credit and the two scores will be different. The individual with the greater amount of debt relative to available credit is penalized for that position.
The credit utilization rate factor that goes into credit score models is why the common advice on credit card for consumers is to avoid running up one credit card to its maximum limit, rather it is generally believed that to maintain or improve a credit score, the credit card balances should be spread out among different cards and therefore reduce the relative amount of debt to credit limit or credit utilization rate per credit card.
With credit cards companies reducing their credit card exposure by dropping credit card limits on customer accounts, it is possible that these consumers are now finding their credit scores dropping as well. In a recent FICO score study, the company found that that approximately 20 percent of the U.S. population experienced a reduction in total revolving credit between October 2008 and April 2009. In general big reductions in credit limits will work the same as increases in the debt by reducing the amount of available credit and subsequently result in a negative impact on a credit score.
According to data from FICO score, the scores derived assess a lot of data and the effect of a single factor like a credit limit reduction on an individual credit score will depend on what other data is on the credit report and how much the credit card limit or line is reduced.
The key factors that impact the credit score in conjunction with a credit limit reduction, according to the folks at FICO score, include: the amount by which their credit limit is reduced, what actions are taken by the consumers in reaction to the reduced credit limit, such as, late monthly payments, changes in the account balances, or opening a new accounts, as well as any other changes in the individuals credit report after the credit limit is reduced.
The negative impact of the reduced credit limit is therefore substantially mitigated by either positive steps of the consumer such as reducing credit balances or financial missteps such as late payments. A credit limit reduction on a single credit card account won’t necessarily damage someone’s credit history or credit score. The final impact will vary depending on each person’s unique credit profile.