Paying right debt will fix credit faster

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Dear Debt Adviser,
Due to some horrible credit card habits in college, I racked up $26,000 in credit card debts. I realized the error of my ways several years ago, and managed to whittle it down to $9,000 currently. However, one account went into collections, then disappeared for many months, and was bought and sold by several different law firm-fronted collection companies. Finally, one that was in my state filed a suit. I entered into a consent to judgment, agreeing to pay a monthly amount I could handle. It then showed up on my credit report as a public record. I recently came into $5,000 (legally), and want to know if I should pay off the collection agency with the judgment, or pay off two, smaller-balanced credit card accounts that still exist?
— Greg

Dear Greg,
Shaving $17,000 of high-interest debt is more than just whittling, although at times I’ll bet it seemed like you were attacking an oak tree with a penknife. With around $4,000 of debt left after your next big pay-down, I’m less concerned about the relative cost of your remaining collection account versus your other credit card debt than I am with rebuilding your credit to get you back into the prime credit pool.

As a young and gainfully employed person, you will likely need access to credit sooner rather than later for life’s good stuff like vehicles, a home, an engagement ring, etc. My objective is to get your credit to be in the best shape possible as quickly as possible so you can enjoy all that life has to offer. And to do that, chances are you’ll be applying for a loan, a new job or new credit at some point.

With this in mind, I recommend that you pay off your judgment. Although paying it off will in no way eliminate the public record from your credit report, a paid judgment is much better in the eyes of anyone reviewing your credit report, whether it be for a loan, job, promotion or insurance, than an unpaid judgment. Additionally, once the judgment is paid in full, it will begin to age and count for less in your credit score as you put some time between it and your last payment. Then, by adding positive information to your credit report from your remaining credit cards by making on-time payments, your credit should begin to show real improvement.

My guess is that within two years, the judgment should have very little effect on what you will be charged for credit. During those two years, just be sure you make all other creditor payments on time and as agreed. Current positive information will outweigh older negative information.

There is another thing I recommend you do to ensure that this doesn’t happen again. That is to take at least half — if not more — of the remaining money from your windfall and stash it away as part of your emergency fund. Without adequate savings, you will constantly be in jeopardy from life’s setbacks and less able to take advantage of its opportunities. What you do with the residual of your $5,000 is up to you. My advice is just to make sure it’s memorable as this sort of good news doesn’t come around every day.

Keep making payments on the two smaller credit card accounts and before you know it, you will have paid your balances and your dues from a hard lesson in what happens when using credit cards to extend your income.

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