Should I Pay Off Collections Before Applying for a Mortgage?

Editor’s Note: This post was originally published in October 2016.

When you’re planning to buy a home, there’s a lot of preparation to do. As a buyer, you probably need to save for your down payment and closing costs, and you may need to get your credit in order. 

For some people, that last item means dealing with old collection accounts. But should you pay off the debt? Or is it better to save your money for a down payment?

If you have the money, and you’re planning to apply for a mortgage in the next few months, paying off collections is usually a good idea. The accounts can weigh down your credit scores, since they show lenders that you failed to pay back your debt. On top of that, some mortgage lenders may ask you to pay off old debt before they’ll approve your loan. 

However, it’s important to note that paying off old collections may not improve your credit scores. 

Can collection accounts prevent mortgage approval?

Mortgage lenders usually don’t like to see unpaid collection accounts on your credit reports. Why? One reason is that they represent a financial liability for you and for the lender. Sure, there’s a chance the collector will not come after you for the money, but there’s also a chance that they could take you to court to demand payment. 

What if they sue you and win the lawsuit? If this happens, the collector can recuperate the funds by whatever means are allowed by law. Depending on the debt collection laws in your state, this could include:

• Garnishing a portion of your wages
• Placing a levy on your bank accounts or investment accounts
• Placing a lien against your property

The collector can also file the judgment with your state licensing board to revoke your professional license. 

As you can see, several of the above outcomes could impact your ability to cover your mortgage payments. As a result, lenders will typically ask you to pay off the collection accounts as a requirement for mortgage approval.

Should you pay off old collection debt? Check the age first.

Before you pay off any collections, it’s important to consider how old the debt is. If the debt is several years old, there’s a chance the collector can no longer sue you for the money. There’s also a chance the information could be removed from your credit reports soon, without any effort on your part.

Here are two important collection timelines to be aware of:

• Statute of limitations: The statute of limitations on debt is the timeframe in which collectors can legally sue you to collect payment. If your state’s statute of limitations for the debt has passed, the collector cannot sue you. 
• Credit reporting timeline: Negative information, such as unpaid collections, will be removed from your credit reports after seven years from your most recent missed payment. Negative items have the most significant impact when the information is new, but the impact lessens over the course of those seven years.

If you’re not sure how old your debt is, you can pull your three credit reports (Equifax, Experian and TransUnion) for free from AnnualCreditReport.com. You can also meet with an NFCC-certified credit counselor to get professional help reading your reports, and to get advice on making improvements.

When you look at the reports, be sure to find the estimated year of removal. You can also look for the “Date of First Delinquency” and add seven years.

Does paying off collections improve your credit scores?

If you pay off your collections, their status will change to “paid” on your credit reports in roughly one to two months. However, the accounts, and any missed payments related to them, will remain on your reports for the full seven-year timeline. That means they can still impact your credit scores. On the bright side, the influence of negative items lessens over time.

Some people try to get around this by doing what’s called a “pay-for-delete”. With pay-for -delete, you ask the collector to remove the account from your credit reports in return for your payment. However, it’s important to note that even if the collector says they will delete the account, they have no legal obligation to follow through.

Is paying off collections the right choice for you?

Paying off collections before applying for a mortgage is generally a good idea. However, before you send payments to anyone, ask yourself the following questions:

• Can you afford to pay off the collection accounts?
• Would you qualify for a better mortgage if you saved your funds for a down payment?
• Are you still within the timeframe to be sued by the debt collector?
• Are you certain the debt will still be on your credit reports when you apply for a mortgage?

If your answer to all of these questions is “yes,” then it’s a good idea to pay off your collection debt. Doing so will show lenders that, although you made mistakes in the past, you are now in a more stable financial position. It can also help you qualify for a better loan, with lower interest rates.

Looking for additional ways to manage debt or qualify for the best mortgage available? NFCC-certified financial counselors are always happy to help!