Ask Liz Weston

Get smart with your money

Credit & Debt

Why high credit scores take longer to heal

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Dear Liz: I am confused about your recent article about a person who did a short sale and questioned its effect on her credit. You said that if she started with a score of 680, it would take about three years for her FICO numbers to return to normal. You then said, “If your scores were high, say 780, it would take about seven years to restore them to their old peaks.” This doesn’t make sense to me. Why would it take longer to recover if you started with better credit?

Answer: Think of credit scores as a mountain that gets steeper the higher you climb. Not only does it take longer to achieve the lofty peaks, but if you tumble down the mountain, it will take you longer to return to those peaks than to achieve some intermediate stage.

The FICO formula is designed to reflect your likelihood of default. If you’ve recently missed a payment, had a bill go to collections or had a foreclosure or short sale, the formula assumes you’re much more likely to default on another bill than someone who doesn’t have those black marks on his or her record, and your scores fall to reflect that higher risk of default. As time passes and you handle credit responsibly, your scores will begin to slowly rise, but it will take more time to regain your peak scores if they were high.

Something else to understand is that the penalty for most negative credit events is greater for people with high scores than those with lower scores. Missing a single payment can knock up to 110 points off a 780 score but might deduct just 60 points from a 680 score. That’s because a higher risk of default is already “baked in” to the lower score. The higher score presumes you’re less likely to default. If you do miss a payment, the formula is set up to punish you more. In most cases, though, you won’t “fall down the mountain” as far as someone who started with a lower score. After the missed payment, the 780 score could be 670, while the 680 score could be 620.

Will her bad credit prevent him from getting a mortgage?

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Dear Liz: Is it possible for me to buy a home without having my wife on the mortgage? She lost her business because of the recession. I do not want to deal with her creditors.

 Answer: You can apply for a mortgage based solely on your own income, credit scores and debt-to-income ratio, if those are sufficient to buy the house you want. Your wife’s income and credit does not have to be considered.

If you can’t swing the purchase without her income, though, you’ll both need to spend some time improving her credit scores. That might include adding her as an authorized user to your credit cards. Another option is to negotiate settlements with her creditors in return for their deleting the collection accounts from her credit reports. You’d want to be cautious in these negotiations, especially if the statute of limitations on the debts hasn’t expired and your wife could be sued. Consider visiting DebtCollectionAnswers.com for help in negotiating with creditors.

Why some debtors don’t get sued

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Dear Liz: You recently answered a question from a business owner who defaulted on some credit card accounts and wanted to know how to pay these old debts. How is it that this person has not been subjected to numerous judgments on the cards in question? In fact, how could he or she have proceeded in business without being subjected to garnishment of accounts?

Answer: To get a judgment and a garnishment, the credit card company or a subsequent collector typically must sue the borrower in court. Different collectors have different policies about when to file such lawsuits. Sometimes they decide it’s not worth the hassle given the slim chances of collecting. However, many collectors also regularly check’ credit reports to see if a debtor’s financial circumstances seem to be improving. If they see signs of such improvement, they may renew collection attempts, including lawsuits.

Old debts don’t disappear

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Dear Liz: I am astonished you would counsel someone to try to negotiate a settlement of credit card debts from 2003 that were written off in 2007. Why? The statute of limitations is no more than six years in California and can be much shorter in many other states. If a reader of your column begins to negotiate over debts that are that old, they risk creating a new debt or resurrecting the old one, thereby becoming liable for repayment of a debt that is not collectible. When there is a stale claim, the response to the collection agency needs to be: “This is a stale claim, the statute of limitations has expired. I do not owe this debt to you or to my original creditor. Please stop contacting me.”

Answer: Statutes of limitations limit how long a creditor is supposed to be able to sue a borrower in court. The statutes vary by state and the type of debt, but range from three to 15 years. The expiration of that limit doesn’t make the debt somehow disappear or prohibit a creditor from continuing collection efforts.

Many people feel a moral obligation to pay their debts when they can. Others want to negotiate to remove collections from their credit reports in return for payment. (Time limits for reporting negative items on credit reports are different from state statutes of limitations; in most cases, the limit is seven years and 180 days from the time the account first went delinquent.) If someone wants to get a mortgage, for example, a lender may require payment of an open collections account regardless of the state statute of limitations.

You’re correct that anyone who wants to negotiate a settlement of an old debt should be aware of the statute of limitations affecting that debt. If the limitation hasn’t passed, the borrower needs to be aware of the danger of getting sued. If the limitation has passed, the borrower needs to avoid restarting it by making a small payment. Instead, the best approach is to settle for a lump sum and to get the collector’s assurance, in advance and in writing, that the remaining debt will be forgiven rather than resold.

Short sales, foreclosures have similar effect on credit scores

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Dear Liz: I went through a divorce in the last year after being separated for two years. During our separation, we closed credit cards with high balances to make sure neither party would spend more on credit. We also had to short sell our home. So, as a single woman in her mid-30s, I have credit that’s somewhat shot for now. How many months should I expect the short sale to affect my credit scores? And was closing the credit card accounts good or bad for my credit?

Answer: Closing credit accounts can’t help your credit scores and may hurt them. In a divorce, however, it’s usually wise to close all joint accounts. Otherwise, your credit rating is in the hands of your ex-spouse, who could trash your scores by paying accounts late or maxing out credit lines.

In any case, the short sale probably had a much greater effect on your credit than the account closures. Short sales typically damage your credit as much as a foreclosure, according to the company that created the leading FICO credit score. Recovery times are measured in years, not months. If your scores weren’t that high to begin with — say 680 in the 300-to-850 FICO scale — it would take about three years for your numbers to return to their old levels. If your scores were high, say 780, it would take about seven years to restore them to their old peaks.

These recovery times assume you handle credit responsibly from now on. That means having and lightly using a credit card or two, making all payments on time and ensuring no account goes to collections.

How to settle old debts

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Dear Liz: I defaulted on my credit cards starting in 2003 because my business was failing. The last account was charged off in 2007. My business is now back and doing well, and I am expecting a nice little windfall in a couple of months. Should I pay these amounts I owe to the collection agencies that have been calling me, or should I contact and pay the creditors from which I obtained the credit cards?

Answer: You can try contacting the original creditors, but most likely they will refer you to the collection agencies. The original creditors have long since taken a tax deduction for their losses and sold the debts to those collectors, so they typically can’t accept payment for these accounts.

The collectors probably paid pennies on the dollar to buy your debts. The older the debt, the less they probably paid. Keep that in mind as you’re negotiating settlements of these debts, because you don’t have to pay 100 cents on the dollar for the collection agencies to realize a considerable profit.

As part of your negotiations, you’ll want to make sure to get the collector’s promise — in advance of any payment from you, and in writing — that it will not resell any unpaid portion of the debt. You may still face a tax liability on this unpaid debt, however, because debt forgiveness is typically considered taxable income.

You also should try to get the collector’s assurance — again, in advance and in writing — that it will stop reporting the collection accounts to the credit bureaus. This won’t eliminate the damage the unpaid debts are having on your credit scores, because the missed payments and charge-offs will remain on your credit reports for seven years and 180 days from when the accounts first went delinquent. But eliminating the collection accounts could boost your scores a bit.

Be aware that in many states, your debts are too old for creditors to sue you in court over them–unless you do something like make a partial payment that can restart the so-called statute of limitations. You can read up on how statutes of limitations work at sites such as DebtCollectionAnswers.com, and learn how to conduct such negotiations without inadvertently restarting the statute.