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Don’t “Reactivate” A Collection Account When Applying For A Mortgage

Gina Pogol
The Mortgage Reports contributor

Collections: Pay Them Off Or Leave Them Alone?

Personal finance experts recommend that you check your credit report before applying for a mortgage. If you find reporting errors, you can work to have them removed before you apply for your home loan.

A rapid rescore can remove erroneous information from your report. The process has been known to increase scores by 100 points or more in a matter of days.

But what if your credit report has a collection account on it, and it’s no mistake?

Should you pay it or leave it alone?

Sometimes, paying off a collection account can hurt your credit score, as counter-intuitive as that might sound.

Your options depend on the type of collection you have, and how long you’ve had it.

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What To Do With Old Collections

If you have a collection account that’s a few years old, you’ll want to dig a little deeper.

Check local statute of limitations

Every state has statutes of limitations on debt collection — typically three-to-six years.

Bill collectors cannot sue to collect debts if they’re too old.

However, you could accidentally restart the clock, making the debt collectible again, if you acknowledge that you owe the money, make a partial payment, or even promise to pay any part of it.

Delete erroneous or outdated information

You may not actually owe the money. Old debt is a huge industry. Buyers purchase the right to collect written-off accounts for pennies on the dollar and then try to collect.

However, they don’t necessarily verify that the debt is real and that it’s yours. You may have never owed it, or you might have cleared the account years ago.

Don’t reactivate the account

It sounds ridiculous, but paying the account might harm your credit score.

Collection accounts are considered serious derogatory items on your credit history, and they do knock your score down significantly.

However, the older the account is, the less damage it does to your credit score.

Paying an old collection makes it appear new again to credit bureaus, and you can actually harm your score.

How should you deal with an old collection? First, do not talk to any bill collector who contacts you about an old debt. You don’t want to accidentally restart the clock.

Request in writing documentation proving that you owe the debt and indicating that the collector is authorized to collect it. If they can’t prove you owe it, dispute it with the credit bureaus.

If a collector tries to report an old debt to credit bureaus as though it were new, that’s a violation of the Fair Credit Reporting Act, and you can have it removed. You can also make the creditor stop contacting you about a debt with a written request.

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Establish A Payment For Large Collections

If you have a large debt, many lenders add five percent of the outstanding balance to your debt payments, reducing the amount that you qualify to borrow.

If you have a $20,000 balance, for instance, FHA lenders add $1,000 to your monthly debt service. That is likely to torpedo your chances of qualifying for a home loan.

Establish a repayment plan with the creditor. The actual payment will be used.

Removing New Collections

Your lender may require you to pay off a recent collection account. Fannie Mae, for example, says, “Delinquent credit…that [has] the potential to affect Fannie Mae’s lien position or diminish the borrower’s equity must be paid off at or prior to closing.”

This is why you may want to pay off a new, valid collection before applying for a home loan. However, you should negotiate the reporting of that debt when you discuss repayment terms.

When an account goes to collection, your credit report will likely take two hits — the first from the original creditor and the second from the collection agency.

The collection agency or original creditor may be willing to erase their negative report in exchange for payment.

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How To Negotiate With Collection Agencies

If you want to pay the debt in full or start a repayment plan, you’re probably better off negotiating with the original creditor.

Contact them first about paying the debt and removing the negative notations from your credit report. If they refuse to deal with you, send a letter to the collection agency. You can find good sample letters online that you should be able to adapt for this purpose.

Don’t tell the creditor that you’re trying to get a mortgage. That puts you in a weak negotiating position.

Get the agreement in writing. Ideally, a letter to you from the creditor confirming that it owns the debt, detailing the agreement and promising to remove the collection and charge-off from your credit history.

Alternatively, send the creditor a letter explaining the agreement you want and asking them to sign and return it before you send them any money. Forward a copy of the signed letter to the collection agency.

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More Leniency For Medical Collections

Medical collections are not usually required to be repaid before you close on your mortgage. They also do not harm your credit score as much as other collections. If you pay them off, they don’t continue to detract from your FICO.

Collections can require a variety of responses — you may be legally obligated to repay them, morally obligated to repay them, or have no obligation at all. If you’re not sure, a good mortgage lender can help you sort them out.

What Are Today’s Rates?

Mortgage refinance rates, as well as rates to buy a home, are low, making homeownership affordable.

Get a mortgage quote now. Quotes don’t require a social security number to start, and there’s never any obligation to continue if you’re not satisfied with your rate.

Verify your new rate (Nov 14th, 2019)