Does It Hurt Your Credit Score if You Pay a Settlement From a Collection Agency?

If you get to the point where you are considering paying a settlement from a collection agency, your credit score is probably already severely damaged. The simple act of paying your settlement may not damage it further and may actually increase it. However, you may have to face additional financial consequences even after you pay a collection agency settlement.

Debt Collection Settlement

A collection agency exists for just one reason: to collect on outstanding debts. If you are contacted by a collection agency, you may be able to negotiate a settlement for less than you owe on your original debt, as the agency would rather collect something than go through the time- and cost-intensive process of suing you to collect the full balance.

Settlement and Credit Scores

If you are making a settlement payment with a collection agency rather than with the original creditor, it usually means that you have fallen behind at least a few months on your payments. By this point, your credit score has suffered significant damage, as your score begins to decline as soon as you miss your first payment and gets worse from there. If you do settle your debt with a collection agency, while your credit report will reflect that you did pay off the account, it will remain on your report for up to seven years. Additionally, if you settle for less than the full amount, this will also reflect on your report. In either case, the account will show under the "negative accounts" section of your credit report and can damage your score.

Tax Consequences of Settlement

One often overlooked negative aspect of settling with a collection agency is the potential tax bill. In most cases, if you pay off your debt with a collection agency for less than you actually owe, the forgiven balance is taxable income. The collection agency will send a 1099-C tax form at the end of the year to both you and the IRS specifying the amount of forgiven debt. You must include this debt as income when you file your tax return.

Bankruptcy

Whether or not you pay your collection account, it will remain on your credit report for years and damage your credit score. If you file bankruptcy instead of settling your debt, you will also damage your credit score, and the filing will appear for as long as 10 years, but you can avoid the negative tax ramifications of debt settlement.