Should I Pay Off Old Debts to Improve My Credit?

Your credit report and credit score are important factors that lenders use to evaluate your creditworthiness and determine if you qualify for new credit products like credit cards, auto loans and mortgages. Payment history makes up a significant portion of your credit score so if you have old, unpaid debts lingering on your report, it could be negatively impacting your score. This raises the question – should you pay off those old debts to improve your credit? Here’s what you need to know

The Pros of Paying Off Old Debts

There are some potential benefits to paying off old debt that is still being reported on your credit report:

• It shows you are committed to paying your debts. When lenders review your credit report and see that you’ve paid off old debts it demonstrates you are making an effort to take care of your financial obligations even if they are very old. This could make you appear less risky.

• It may improve your credit utilization ratio. Your credit utilization ratio is how much credit you are using compared to how much you have available. Keeping this ratio low is important for your credit score. Paying off old debts can lower your overall utilization.

• It could positively impact your payment history. Payment history makes up 35% of your FICO credit score. If the old debts you pay off had late payments associated with them, getting them paid off and up-to-date could help improve this aspect of your score.

• You may qualify for better loan terms. Even if paying old debts doesn’t significantly improve your credit score some lenders do look deeper at your full credit report. Settling old debts that are still being reported could make you eligible for better interest rates or more favorable loan terms.

• No more collections calls. Finally clearing up old debts can stop debt collectors from continually pursuing you and contacting you for repayment. This can provide significant peace of mind.

The Cons of Paying Off Old Debts

However, there are also some potential drawbacks to consider when deciding whether to pay off old debt:

• The debts may be close to falling off your report. Most negative information falls off your credit report after 7 years. If your old debts are getting close to hitting that mark, you may want to just let them naturally fall off instead of paying them.

• It restarts the statute of limitations. The statute of limitations sets the timeframe that creditors can sue you over debts. If you make a payment on a debt that is nearing the statute of limitations, it resets that timeframe.

• There may be minimal score impact. Debts can remain on your credit report for 7 years, even after being paid off. And accounts that have been charged off by the lender will still show as “paid charge offs” even once settled. So paying them may not bump your score up significantly.

• You’ll have to cover the cost twice. If a debt is so old that it already negatively impacted your score for years, you’ll essentially have to pay for that credit mistake twice – once in the form of the initial score hit, and again when you actually pay off the debt.

Weighing the Pros and Cons

Whether paying off old debt makes sense depends on your specific financial situation. Here are some things to consider:

• How old are the debts? If they are very close to dropping off your report you may want to just let them.

• Will paying them off substantially improve your credit utilization ratio? If so, it may be worth it.

• Do they have late payments you want to get removed from your history? Settling them could help.

• Is your credit score already in good shape? If so, paying old debts may not make much difference.

• Are collectors constantly hounding you? Getting them paid off may be worth it for peace of mind.

If you are unsure if paying off old collections and charge offs is the right move, consider speaking to a credit counselor. They can review your full credit profile and provide tailored advice based on your specific situation. A credit counselor can also help you negotiate with creditors and collectors to pay off debts in a strategic way that optimizes the benefits to your credit.

Other Ways to Improve Your Credit

Paying off old debt is just one potential step to take to boost your credit. Here are some other effective ways to improve your credit score over time:

• Pay all current bills on time. Payment history is very important, so staying current on all your existing credit accounts will benefit your score. Even just one late payment can drop your score.

• Keep credit card balances low. Having high balances close to your credit limits hurts your score. Keeping balances under 30% of your limits can help.

• Limit new credit applications. Each new credit application causes a hard inquiry on your report, which can ding your score a bit. Only apply for credit you need.

• Monitor your credit report. Check your credit reports from all three bureaus once a year for errors that could be depressing your scores and dispute any inaccuracies found.

• Build credit history. If you have limited credit history, consider becoming an authorized user on someone else’s credit card or taking out a credit builder loan to start establishing a payment record.

• Practice good credit habits. Using credit cards responsibly and maintaining healthy financial habits will help build your scores over time. Be patient as it takes perseverance to significantly improve credit.

By paying close attention to your credit profile and practicing good credit habits, you can rebuild and improve your credit scores without necessarily having to pay off old debt collections. Speak to one of our credit counselors to get personalized advice about the best ways to boost your credit.