Credit is an important factor in maintaining your financial stability. In fact, bad credit can break deals you want to make, from big purchases to relatively minor things like getting a new credit card. Your payment history primarily decides your credit rating, and it can be tricky to maintain a positive score. One factor that can have a large impact on your credit file is collections.

While missing a few payments may be something you can salvage with relative ease, repeatedly failing to pay can result in your account reaching collections and ultimately hurting your credit report. Collection agencies can have a negative impact on your score that is difficult to overcome. Paying off these collections can help, but it is essential to do this in the right way to maximize benefits.

How do collections agencies work?

Debt-collection agencies (not credit repair specialists) specialize in collecting debts from customers where the original creditors have failed to get arrears on an account paid within a satisfactory period. They work in two ways:

The original creditor, that is the company you originally owed the money to and took out the loan with, sells or assigns your debt to a collections agency. Companies turn people over to bill collectors usually if the amount you are paying them is not enough, or if you miss payments repeatedly. When you take out the original loan with the creditor, there is a clause permitting them to go to collections should you default.

This arrangement benefits the original creditors; they sell the debt at a reduced amount and so receive a lump sum of money to help recover their losses. The collections agency, meanwhile, becomes the legal owner of the debt. Their profit comes from collecting the total amount of the debt from you.

In the second option, the creditor still owns the debt, but they contact you using a collection agency. The agency retains a percentage of the money collected.

The consumer can tell which of these options is being used by consulting the letters received from the debt collection agency. If you are asked to continue paying the original creditor, the debt will likely be owned by them.

Agencies can be a popular choice for creditors, as debt collection is a way for them to get their money back if the customer has defaulted. Though this may be a lower amount, it offers a guarantee that the consumer may not.

Should I pay collections agencies the debt I owe?

If you have defaulted on your payments or paid less than the minimum agreed, paying collections agencies may become the only option you have for paying off your debt.

One advantage that agencies may have over the original creditors is that once the debt goes to an agency, charges and interest may stop. It is important to remember that if the original creditor still owns the debt, they may continue to add fees and interest while the collection agency is contacting you. These charges are one of the reasons it is essential to engage with and respond to agencies quickly once they contact you; it could save you money.

Your credit score is affected mainly by payments. Making regular payments on your accounts helps boost your score and keep you in good standing with potential lenders.

Once your debt passes to a collections agency, it is possible to adjust repayments to suit your circumstances better. Agencies are likely to have more flexibility and so may accept a lower monthly repayment to help you clear the debt. This leniency should help you meet the amount each month, and in turn, boost your score.

Collection agencies may seem intimidating, but it is important to remember that they do not have any more power than the original creditors. They could potentially take you to court if you fail to pay. But good communication and an effort to agree to an arrangement is a huge help and can help you clear the debt and improve your score over time.

Will paying off collections agencies improve my credit score?

As we have discussed, the easiest way to improve your credit score is to make regular payments on your accounts. Logically then, one would assume that paying off your collections will help to boost your score, but this is not necessarily the case.

An account reaching collections is a very negative blow to your credit score. Paying off the amount, therefore, is unlikely to have a significant impact on improving the figure. The benefit is in the lenders; they are more likely to look favorably on an applicant who has paid off an account—albeit at a later date—than one who completely neglected the issue.