Legally, you owe a debt until it’s paid, settled, or wiped out in bankruptcy. Some people erroneously believe that their obligation ends when a creditor charges off the debt. But a charge-off is essentially just an accounting term. The creditor can continue trying to collect or sell the debt to a collection agency, which can try to get you to pay. Your obligation to pay doesn’t end when an unpaid debt falls off your credit report after seven years. The creditor might not be allowed to report the account, but collection actions can continue. Similarly, your state’s statutes of limitations define how long a creditor or collection agency can take you to court over a debt. But even if you can’t be sued, a creditor or collector can still ask you to pay. Given all that, shouldn’t you just pay what you owe if you possibly can? Many people would say yes, pointing out that we have a moral obligation to pay the debts we incur. But the answer to this question is actually trickier than it might appear, for several reasons.
Paying Old Debts Might or Might Not Hurt Your Credit Score
For years, a quirk in the credit-reporting process meant that paying old debts could actually hurt your credit. When the creditor or collection agency updat¬ed your credit report to reflect the payment, the FICO formula was often fooled into thinking the old, troubled account was newer than it actually was. Because the formula is designed to weigh recent behavior-good and bad- more heavily than past behavior, anything that looked like you had incurred recent problems could really hurt.
Fair Isaac worked with the credit bureaus to fix this problem. The issue can still pop up, though, if your lender is using an old version of the FICO formula to compute scores. Fair Isaac spokesman Craig Watts said the company doesn’t know how many lenders use the old versions, but he thinks it’s a “very small percentage” of the total. Still, it’s possible that paying old debts could hurt you in the eyes of some creditors.
Just Contacting an Old Creditor Can Leave You Vulnerable to a Lawsuit
Each state has different guidelines on how long a creditor can sue you over a debt, but some states have provisions that allow this statute of limitations to be extended if you make a payment on an old debt or even acknowledge that you owe it. You could be making a good-faith effort to pay your bill or be talked into making a “token” payment as part of negotiations with a collec¬tion agency, and the creditor could use that as an excuse to haul you into court and get a judgment against you-an action that might not have been permitted if you had just left the debt unacknowledged and unpaid. The judgment would be a new and serious black mark on your file that could be reported for another seven years.
You’re Often Not Dealing with the Original Creditor
The company that you owe the money to might have long since cleared the debt off its books, taken a tax write-off for the loss, and sold the debt, usually for pennies on the dollar,to a collection agency. The original creditor might not accept money if you tried to offer it, but would instead direct you to the collector. Many people understandably feel less obligated to a collection agency that bought their debts for a tiny fraction of face value than they do to the company that originally extended the credit.
You Might Be Exposing Yourself to Some Pretty Nasty Characters
Despite laws designed to curb them, many collection agencies employ people who lie to, harass, and abuse borrowers. They might scream at you, use obscene language, or threaten you with jail time. (All of these actions are, of course, illegal, but if you don’t believe they happen, you need to take a look at my mailbag.)
Even if collectors are polite to your face, they might do things behind your back to further endanger your financial life. Collectors might promise to drop a harmful remark from your credit file, and then not follow through or make the black mark even worse. They might arrange a deal that they say will settle your debt, and then sell the unpaid portion to another agency that renews collection activity. Or they might report any debt you didn’t pay to the IRS, which can tax the so-called forgiven debt as income.
More than a few collectors feel that anything they do is justified because, don’t you know? debtors are bad people. The fact that owing money is usually not illegal-but that violating fair credit¬reporting and collecting laws is-remains a distinction that completely escapes them.