If you don’t pay your bank loan, credit card, or other debt, the lender may decide to send your file to a collection agency. A collection agents job is to phone you and take whatever measures they decide are necessary to collect the money. They want to collect because that’s how they get paid.
If you have the money, you may assume it’s in your best interest to pay them, so they stop calling you and so that it clears up your credit. Those are logical assumptions, and yes, making the phone calls stop is a worthy objective, but does paying a collection agency “clean up” your credit report?
Not exactly, and that’s why it never makes sense to pay a collection agency. Notice I’m not saying don’t pay off your debt, I’m saying don’t pay a collection agency. The reason is how you decide to pay off your outstanding debt will affect how long it will remain on your credit report.
To fully explain this somewhat complicated issue I’m going to walk through an example:
You lost your job and stopped paying your credit card and it went to collections. One year after you stopped making payments you were back to work and were able to save (or borrow from family) enough money to pay off the debt.
What should you do?
Scenario #1: You Pay The Collection Agency
The obvious option, since you now have the money, would be to pay the collection agency. However, according to Equifax, Canada’s largest credit reporting agency, once you pay this debt it will remain on your credit report for six more years from the date of payment, because normal credit transactions remain on your credit report for six years. Even if the collection agency agrees to accept less than the full amount owing, it’s still on your credit report for six more years.
Scenario #2: You Don’t Pay At All
You could simply not pay the debt. The collection agency will continue to phone you, and the lender may even decide to take you to court and garnishee your wages, so if they know where you work this may not be a good idea. However, if they don’t take you to court, the debt is automatically purged from your credit report six years from the last activity, so in the example above that’s five more years from when you stopped paying a year ago. Oddly enough, by not paying, the debt is actually removed from your credit report one year earlier than if you actually paid the collection agency! Now I don’t really recommend this course of action, I just want to illustrate why paying the collection agency is not necessarily the best choice.
Scenario #3: You Do A Debt Management Plan
If you have the money to pay the debt and want to clear it up, you could go to a not for profit credit counselling agency and arrange a debt management plan. Typically in a DMP you offer to pay the debt in full over a period of time (say three to five years, by way of monthly payments). However you have the money available now so you could offer to pay perhaps over 12 months. Once the credit card company agrees to the deal, you simply pay it off. Here’s the key: Because it was a credit counselling payment, Equifax will automatically purge the debt three years from the date paid. So, by paying through a not for profit credit counsellor, the debt can be removed from your credit report as much as three years sooner than if you paid the debt through the collection agency.
In the first two examples I have assumed you have paid the debt in full. (With credit counselling all debts must be paid in full; the collection agency may be willing to accept less than the full amount owing).
Scenario #4: File A Consumer Proposal
If you don’t have the funds in full it’s still not a good idea to settle directly with the collection agency. A consumer proposal covers all of your standard unsecured debts, so whether or not this is a viable option will depend on what other debts you have, and other factors such as your income and other assets. However, if a consumer proposal is a viable option for you, you may be able to pay less than the full amount owing, and the proposal is purged from your credit report three years after you make your final proposal payment. Depending on the length of your proposal, this may or may not be sooner than paying directly however again, the benefit here is you are also dealing with all your other debts.
- If you pay the collection agency directly, the debt is removed from your credit report in six years;
- If you don’t pay, it’s purged in five years (in this example), but you may be at risk for wage garnishment;
- Through a not for profit credit counsellor you can pay in full immediately and have the debt removed from your credit report in three years;
- You can file a consumer proposal and, if you qualify, pay less than the full amount owing and be clear of the debt three years after your final payment.
As you can see, there are really no obvious scenarios where it makes financial sense to pay a collection agency directly. I’ve illustrated this point with a specific example, and your circumstances may be different, so it would be prudent to consult a financial expert to review your unique situation before deciding on the strategy that’s best for you, but it’s likely that paying the collection agency will not be your best option.