Should you pay debt in collection?

Dear Debt Adviser,
Other than the moral issue, what is the point of paying off debt that has gone into collection? Does it raise my credit score? I don’t plan on making any large purchases any time soon, and I pay my bills on time. However, I had to deal with a pay cut and it took about six months to get back on track.
— Slipping Into Debt

Dear Slipping Into Debt,
I’m sorry to hear that you had a financial setback, but I’m pleased that you are back on track — sort of back on track, that is. Yours is an example of the damage that can happen to anyone’s financial life with an unexpected interruption in income and an insufficient savings cushion. Personal finance experts don’t advise people to build an emergency savings account of six months’ to a year of expenses because it’s a round number. It’s an essential amount needed to be successful in today’s tumultuous job market. However, what’s done is done, but I hope you will begin to save a cushion as soon as possible.

The issue of paying a debt has never been a moral one in finance. Bankers and brokers are famously amoral in the best of times. The issue is one of trust. The entire financial system, and that includes credit, operates on trust. No trust, no sale! We saw this in spades during the recent credit crisis when the banks refused to lend money overnight to other banks because they didn’t trust that they’d get it back in the morning.

Let me try to bring this closer to home for you. One reason to pay a debt in collection is aggressive collection practices. After six months, when the debt charges off, it may be sold to a more aggressive collection company or it may be turned over to a lawyer for court action. If you’ve only been through the first six months of the collection process, then as the saying goes, you ain’t seen nothin’ yet!

The second reason not to ignore a debt in collection is an unwanted wage garnishment or bank account levy. If the debt is yours and it has not passed the statute of limitations for collection in your state, then you may be sued in court. If the judge decides in favor of the collector, a judgment may be issued in the amount of the debt plus interest and fees that can be used by the collector to garnish your wages or levy your bank account.

No, paying the debt in collection will not raise your credit score. However, paying it will mean the account is reported as paid on your credit report. You state you are not looking to purchase any large items any time soon, but you have already learned that sometimes life doesn’t happen exactly as planned or as you might wish. The outstanding collection account will remain on your report for seven years from the first date of delinquency. It is likely that you may have to borrow money, seek new employment, be considered for a promotion, apply for or renew insurance or try to rent an apartment in that time period. All of the aforementioned can and often do check your credit before deciding if they can trust you. They are not encouraged to do so when they see any longstanding unpaid accounts on your credit report.

I recommend paying the amount owed on the account in collection because it is the smart thing to do. Determine what you can afford to pay monthly on the debt (unless you can pay the full balance due) and contact the collector to make arrangements to pay. Be sure to get any payment agreement in writing before you start making payments.

Lastly, I encourage you to start that emergency savings account of six to 12 months’ of living expenses to help avoid unwanted debt in the future. I know you are dealing with a decrease in pay, but placing even a small amount in savings will add up over time and will provide you with the financial security and peace of mind that you wish you had six months ago.

Good luck!

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