Facts

• Creditors don't keep old, unpaid debts within their accounting ledgers indefinitely. After a certain period of time, usually 180 days, a creditor will either hire a collection agency to collect the debt by paying it a percentage of the amount recovered or sell the debt to a collection agency outright. When a collection agency purchases a debt, it often can do so for a mere fraction of what the debtor owes. Should the company acquire a payment from the debtor, it may then keep the full amount.
  
  

Significance

• Many collection agencies report the debts they own to the credit bureaus. This can result in a collection account appearing on your credit report. Collection accounts are always a negative entry and can significantly damage your credit score. The credit damage you will suffer depends upon how good your credit was before the collection agency purchasing your debt. The higher your credit was previously, the more damage a derogatory entry will do. Collection accounts for amounts lower than $100, however, will not affect credit scores.
  
  

Time Frame

• The Fair Credit Reporting Act states that collection accounts can remain on a credit report for 7.5 years from the date the debtor stopped making payments on the debt. Most creditors will not turn a delinquent account over to debt recovery agencies until the debt is six months overdue. Thus, few individuals will carry collection accounts on their credit reports for longer than seven years. Although collection accounts have a negative impact on credit scores, that impact decreases over time. For example, a recently added collection account will hurt a debtor more than one that has appeared within his credit record for six years.
  
  

Considerations

• Missing payments on a debt before the creditor offering the debt to a collection agency can damage your credit score just as much, if not more, than the collection account itself. According myFICO.com, the website of the Fair Isaac Corporation, the company responsible for calculating FICO scores, an individual's payment history accounts for 35% of his credit score--a higher percentage than any other single factor. Thus, the collection account may actually damage a debtor's credit less than the debt payments preceding it.
  
  

Misconceptions

• Many individuals believe that paying off a debt that is in collections will result in the entry being removed from their credit files or their credit scores improving. Unfortunately, this isn't the case. When you pay off a debt that is in collections, the collection agency will update the entry on your credit report to reflect that the debt has been paid in full. While this looks better to lenders who review your credit reports, it has no effect on your scores. Some collection agencies, however, will agree to remove the derogatory notation in exchange for payment.