Using Your Tax Refund to Pay Off Collections – Wise or Unwise?

February 4, 2016

Using Your Tax Refund to Pay Off Collections - Wise or Unwise?

Read this article before you use that big wad of cash from your tax refund to start paying off collections in hopes of improving your credit score.

Every year we talk to people that spent their tax refund (often $1000s) on paying off their collections in hopes of improving their credit scores so they can buy their dream house. After all, isn’t it logical to think that paying off collections demonstrates that you’re financially responsible, and shows that you’re less of a credit risk? This is what many people think, including many in the lending and banking industry. Unfortunately, this way of thinking usually winds up being a losing strategy. The brutal consequence is that people end up applying their limited cash toward a “false solution” – one that doesn’t achieve their goal, but instead costs them thousands of dollars.


One couple spent their $7000 tax refund on paying off their outstanding collections and charge-offs. Their loan officer (who was relatively new in the mortgage industry) recommended that they do this to increase their credit score enough to qualify for a mortgage loan. Figuring this made sense, and trusting this “expert” advice, they expected to see a substantial score increase from their credit score of 562. Two months later when the loan officer pulled their credit again, they all expected to see the score increased by 40 or maybe even 60 points…enough to qualify for a mortgage. The report showed that all of the collections they paid were updated to show a zero balance, but to their shock and disappointment, their score went up only 12 measly points. The new score of 574 was still not good enough to qualify for a mortgage approval. Defeated and frustrated, they gave up on the first loan officer and contacted another lender for a solution, and were directed to us for help. We explained why their score had not gone up that much….and more importantly, what they needed to do to increase their score. It became apparent that they needlessly spent $7000.

Deal With Collections… Wisely

Collections Stay on the Report For 7 Years (PAID Or UNPAID)

Many people think paying off a collection will result in the account being removed from their credit report. The truth is that it can continue to report for the remainder of 7 years from when the debt first went delinquent with the original creditor. It’s important to know that paid collections that remain on your credit report will hurt your credit scores.
Try This Idea – Negotiate Removal of the Collection.

Your first option should be to try and negotiate with the collection agency prior to paying a collection. Ask them to remove the collection from your report if you pay it in full. Some collectors will agree to this…but not all. It’s worth asking!
What if Negotiating Removal Doesn’t Work? Should I Still Pay My Collections?

That depends, as the age of a collection has more effect on your score than whether it’s paid or unpaid. This is why paying off old collections doesn’t help your score much. For example, a new collection that is only 3 months old may drop your scores 70 points. Pay it off right away and you could gain back 20 points.

As this collection gets to be about a year old, the adverse impact is about half as much as when it was only 3 months old (in this example it may only drop scores 35 points). Paying it off at this point means you’ll gain even fewer points back (maybe a 10 point increase). As time passes, the benefit of paying off a collection continues to drop. An unpaid collection from 4 years ago may only hurt your scores by 7 points. Paying it might gain you 2 measly points back. So in summary, be sure to take time and evaluate the age of a collection to help you determine if paying it off will give you the score increase you’re looking for.

Take a Bird’s Eye Approach When You Evaluate Paying Off Collections

If your credit report has a long list of negative accounts reporting, and your score is about 560, then paying collections will most likely result in a small score increase. When your report shows numerous collections, each collection doesn’t hurt that much on its own. So in this instance, even paying off a newly reported collection may only gain you back 10 points.

On the other hand, let’s say you have stellar credit history, a score of about 720, and a couple of recent collections. Then in that instance, paying those collections off will likely give you a significant score boost.

In both scenarios, keep in mind that there are other things that can affect your score improvement, such as your credit card utilization ratio and the number of open accounts with positive payment history. See 7 Steps to Better Credit.

Actions for Those Who Want a Loan, But Have Unpaid Collections

(1) View a copy of your credit report.

  • Ask for a copy from your loan officer if you applied for credit.
  • You can also set up a free account online with Credit Karma and view your TransUnion and Equifax credit reports.
  • Obtain your free annual credit report from
  • Otherwise, you’re able to purchase a copy of your report from one of the many companies offering this service online.
(2) Review your report and gauge your overall picture.
  • See how many collections are reporting.
  • How old are they?
  • Which ones have outstanding balances?
  • Using the 7 Steps to Better Credit book and worksheet.
    • Review your utilization ratio from your credit cards.
    • Count how many of your open accounts are helping you (only those showing a 100% positive payment history).
    • Identify any other derogatory items reporting.
(3) Discuss all of the financing requirements with your lender. You should know what you are up against before you take action. If these apply, ask about:
  • Judgments & tax liens.
  • Whether any unpaid collections or charge-offs will affect the loan, regardless of credit scores.
  • The minimum score required for loan approval.
  • The acceptable “debt-to-income” (DTI) ratio in comparison to your desired loan amount.
  • Whether your foreclosure or bankruptcy is an issue.
(4) Get Help
Credit repair can quickly and effectively remove outdated, unverifiable, or inaccurate information from your credit report. Through a dispute process used with the credit reporting agencies, many derogatory items can be removed from your credit report, dramatically improving your credit scores. Alongside of this, one of our credit repair specialists would consult with you to simplify the learning process and assist you in constructing an action plan to help you accomplish your financing goals.