Should I Pay Off My Collections to Get Mortgage Ready?

Editor’s note: This post was originally published in October 2016.

When planning to buy a home, there is a lot of preparation to do. As a buyer, you probably need to save for a down payment and closing costs, and you may need to fix your credit.

For some people, that last item means dealing with old collection accounts. But should you pay off the debt? Or is it better to save your money for a down payment?

If you have cash and are planning to apply for a mortgage in the next few months, paying the bills is usually a good idea. Accounts can weigh on your credit scores, as they show lenders that you’ve failed to pay your debt. Additionally, some mortgage lenders may require you to pay off old debt before approving your loan.

However, it is important to note that the payment of old collections may not be improve your credit scores.

Can collection accounts prevent mortgage approval?

Mortgage lenders typically don’t like to see unpaid collection accounts on your credit reports. Why? One reason is that they represent a financial liability for you and the lender. Of course, there’s a chance the collector won’t pursue you for the money, but there’s also a chance he could take you to court to demand payment.

What if they sue you and win the case? If this occurs, the collector may recover the funds by any means permitted by law. Depending on the debt collection laws in your state, this may include:

• Garnish part of your salary
• Placing a levy on your bank accounts or investment accounts
• Placing a lien on your property

The collector may also file a motion with your state licensing board to revoke your professional license.

As you can see, some of the above results can affect your ability to cover your mortgage payments. As a result, lenders will usually ask you to pay collection accounts as a demand for it mortgage approval.

Do you need to pay off old collection debt? Check the age first.

Before paying off any collections, it’s important to consider how old the debt is. If the debt is several years old, there is a chance that the collector will no longer sue you for the money. There is also a chance that the information will soon be removed from your credit reports, without any effort on your part.

Here are two important collection timelines to keep in mind:

• Statute of limitations: The PRESCRIPTION over the debt is the time frame in which collectors can legally sue you to collect payment. If your state’s statute of limitations on the debt has passed, the collector cannot sue you.
• Credit reporting timeline: Negative information, such as unpaid collections, will be removed from your credit reports after seven years from your most recent missed payment. Negative voices have the most significant impact when the information is new, but the impact diminishes over these seven years.

If you’re not sure how old your debt is, you can pull your three credit reports (Equifax, Experian and TransUnion) for free from AnnualCreditReport.com. You can also meet one NFCC Certified Credit Counselor to get professional help to read your reports and get advice on making improvements.

When looking at reports, be sure to find the estimated year of removal. You can also search for “Date of First Delinquency” and add seven years.

Does paying collections improve your credit scores?

If you pay your collections, their status will change to “paid” on your credit reports in approximately one to two months. However, the accounts, and any missed payments related to them, will remain on your reports for the full seven-year timeframe. This means they can still affect your credit scores. On the bright side, the impact of negative items diminishes over time.

Some people try to get around this by doing what is called “paying for deletion”. With pay-for-delete, you ask the collector to remove the account from your credit reports in exchange for your payment. However, it is important to note that even if the collector says they will delete the account, they are under no legal obligation to follow through.

Is paying off collections the right choice for you?

Paying your bills before applying for a mortgage is generally a good idea. However, before sending payments to someone, ask yourself the following questions:

• Are you able to pay accounts receivable?
• Would you qualify for a better mortgage if you saved your funds for a down payment?
• Are you still within the time limit to be sued by a debt collector?
• Are you sure the debt will still be on your credit report when you apply for a mortgage?

If your answer to all of these questions is “yes,” then it’s a good idea to pay off your collection debt. This will show lenders that, although you have made mistakes in the past, you are now in a more stable financial position. It can also help you qualify for a better loan, with lower interest rates.

Looking for additional ways to manage debt OR qualify for the best mortgage available? NFCC Certified Financial Advisors are always happy to help!