Does Paying Off Old Debt Always Make Sense?

Part of building good credit means staying on top of your obligations but if you lose track of a bill somewhere along the way, it may come back to haunt you. Paying off old debt can keep creditors at bay but there are some pros and cons to think about before you hand over the cash.

Time limits on collections

Every state limits how long a creditor has to try and collect on an outstanding debt. The statute of limitations begins on the date of the last activity on the account and it varies based on what kind of debt you owe. For things like credit cards or medical bills it usually ranges from three to six years, although certain states may extend the time frame to as long as 15 years, depending on what type of debt it is and whether you signed a contract or promissory note.

Once the clock winds down, the creditor no longer has any legal recourse to try and get you to pay. That means you can't be sued or be subject to wage garnishment or bank account seizure. That doesn't mean, however, that the obligation just disappears. If the debt is valid, you'll still owe the balance and the only way to make it go away for good is to wipe it out in a bankruptcy filing.

Old debts and your credit score

The biggest chunk of your credit score is based on your payment history. Whenever you pay late or miss a payment altogether, it shows up as a negative mark on your credit report. The more late and missed payments you have, the more your score suffers. Once you get to the point where you've gone 90 days or more without paying, the creditor may just charge the account off altogether. If that happens, your credit score will take an even bigger hit.

Negative marks can stay on your credit history for up to seven years, which can make it tougher to qualify for new loans or get utility services in your name without paying a big deposit. As the debts get older, the impact of late payments or a charge off begins to lessen somewhat, although that doesn't necessarily improve your score. Paying off old debt may pull it up a little if your creditor agrees to report your account as "Paid in Full" or "Paid as Agreed,"  but the impact usually isn't dramatic.

What happens if you don't pay

There are some drawbacks that you need to keep in mind if you decide not to make good on an old debt. Aside from the damage to your credit, you'll likely be targeted by debt collectors, which can be annoying to say the least. Federal law regulates the kind of contact collection agencies can initiate, but at the minimum, you may have to put up with repeated phone calls or a barrage of collection letters.

Even if the debt is outside the statute of limitations, you shouldn't assume those pesky collectors will just go away. Some collection agencies specialize in buying up old debts on the cheap and then hounding consumers into turning over their cash. It's a real possibility that you could get a phone call 10 or even 20 years down the line from a collection agency and if you're not careful, you may fall right into their trap.

One of the things you have to be especially careful about with old debts is not restarting the statute of limitations. Even acknowledging that you owe the money over the phone is enough to reset the clock, which gives collectors additional time to pursue you. When you're dealing with a collector, your best bet is to say as little as possible, especially if the collection window is closing soon. Asking for written validation of the debt and keeping a paper trail of your communications is the best way to protect your rights.

When paying off old debt is the right move

There are several situations where paying off old debt can actually work to your advantage. If you're planning to buy a car, apply for a mortgage loan or refinance your home, your lender is going to take a close look at your credit history. Knocking out those old debts once and for all may not do your score any good but it will show the bank that you're serious about taking care of your financial obligations.

Many employers take your credit into account when making their final hiring decisions. While they can't access your score, they can see your report, including any missteps you've made along the way. If you're trying to land a job that requires a security clearance or deals with the financial sector, an unpaid debt might raise an eyebrow or two. Paying it off can minimize the impact it has on your desirability as a candidate.

Finally, you may want to consider paying off old debt if it all stems directly from medical bills. Thanks to changes in the FICO scoring model, outstanding medical debt won't be weighed as heavily as credit cards, loans or other kinds of debt going forward. If you've got accounts that are in collections and you pay them off, they won't count negatively on your credit. In fact, it can actually have the opposite effect, raising your score by as much as 25 points. That's a definite benefit to keep in mind when you're debating whether to banish those old debts for good.