Credit scoring models are a mystery that boggles the mind. There is no way to know exactly how specific changes to your credit report will impact your credit score. We do know the factors that go into calculating the score – 1) Your payment histories 2) Number of accounts that have balances. 3) Proportion of balances to credit limit. 4) Length of time accounts have been opened. 5) Credit inquiries. 6) Collection Accounts and Public Records. You can read more about this in the articles I wrote entitled How to Get a Great Credit Score Part 1 and Part 2. The scoring models are updated occasionally and the changes cause different issues to play a bigger or smaller role in your score.
This year I have noticed that small collection accounts are playing a much larger role in credit scoring and I have helped 3 borrowers this year to raise their score from 80 to 120 points! That is a huge improvement. How’d you do that, you ask? Here’s the scoop:
Recently I ran a new applicants credit report and his credit score was 702. That’s pretty good but in today’s world it’s not good enough. This borrower would pay a ¾% risk premium that he would not have to pay had his score been 740 or better. On a $200,000 loan that amounts to a $1,500 increase in the cost to obtain the loan or a quarter point increase in his rate. Ouch!
Upon a thorough review of the report I found he had perfect payment histories and very little outstanding debt. His score should be a lot higher. Then I discovered a $32 collection account that had been filed a few months earlier (A collection account is filed when you owe a creditor money and they feel that they cannot recover the money – they hand the account over to a collection agency who records the collection account with the credit bureaus). I advised the borrower to contact the collection agency and tell them that he would pay the $32 if they agreed to remove the account from his report. This is very important – it does not help to pay off the account and have it show on the credit report as paid – the account must be completely deleted from the report.
He followed my advice and paid off the account and got a letter from the collection agency stating the account was paid in full and that they were deleting the record from the credit report. I provided this to the credit bureau’s (called a rapid re-score) and 48 hours later his credit score was 808!! His credit score improved by a whopping 106 points! The savings in this case was $900 in lowered closing costs because he did not have to pay the three quarter point risk adjustment. Well worth the $32 he paid.
The moral of the story here is that if you get a letter in the mail from a creditor saying that you owe 20 bucks to your doctor’s office, Cell Phone Company or anyone else, just pay it before it goes to a collection agency! I know, you’re thinking it’s the principle of the thing. You don’t owe them the money for whatever reason. The bottom line is that it will be a lot more painful to you to not pay it than it will be to just give in and protect your excellent credit rating! Never let any account go into collection or it will have a severe impact on your credit.