Settlement for past due debts on your FICO score this year

If you have one or more past due accounts in collections right now, you may have been contacted by a collections agency or the creditor itself, offering you a settlement on your debt. You may be wondering if it is indeed possible to remove some of the negative impact that this past due debt has had on your credit score by paying off the settlement amount, or even the entire balance.

Everyone wants a good credit score, and sometimes we do make mistakes with our credit. Our credit scores arise from the actions we take every day with our finances and our debts. Anytime we even miss a payment, let alone let a debt go into default, the damage is already done to our credit scores.

Sadly under the old FICO scoring system, paying a settlement on your debt will do very little in the way of credit repair. You will get a slight rise in your credit score, which is better than nothing I suppose. You would get an even slighter improvement on your credit score by paying off the debt in full, under the old scoring system.

The good news is that sometime this year that will change on a wide scale basis. Already 10 credit card issuers have used the new scoring system. It remains to be seen how many creditors will adopt the new scoring system as of now. Well it will change for your FICO score at any rate. Fair Isaac Corp or FICO will not include in your score any debt that has been paid in full or settled. This is being done to help boost consumer lending. The thought here is that if you have repaid your debt, that you just had some financial problems, but that you were still good to your word on repaying your debt. You still receive the hit for the late payments, but not the charge off or debt in default. This new model of FICO score will be known as the FICO9 model.

I should point out that not all lenders will be using FICO9. Indeed some lenders have already stated that they will be using earlier versions of the FICO scoring system. So while you may have a credit score of 690 with one lender, you may have what appears to be a 529 score with another lender for example. Also some creditors use in house scoring systems that only use FICO as a base scoring system, while the in house scoring modifiers change the score substantially.

Rather than worry about paying the debt off just for credit scoring reasons, you should be paying the debt off because you in fact owe the debt. If you start working on your finances so that you never end up in default again, nor end up with late payments, you will in time naturally have a good credit score. Good credit scores follow good credit behavior, it is the natural evolution of good credit behavior. A good budget will help you with keeping up on payments and not over extending yourself where credit is concerned.

I should point out that if you do accept a settlement on any type of debt, that there will be tax liabilities on the amount of debt forgiven. This is because the creditor has written off this debt, debt that the creditor would have paid taxes on, so the IRS instead will turn to you to pay the taxes on the amount of debt that was forgiven. You cannot avoid paying this tax, as the creditor will notify the IRS of the settlement. The settlement is counted by the IRS as a sort of income for you, as you are after all saving money by escaping from the owed debt. This only counts however for debts forgiven that total $600 or more, so you are off the hook for tax liability, if the debt does not reach this amount.