It’s the perfect Catch-22. Because of the lingering foreclosure crisis and the nation’s stagnant economic recovery, the Federal Reserve is holding interest rates at near-record lows, making right now the perfect time to get a mortgage.
But also because of continued problems in the mortgage industry and the economy as a whole, banks are more risk-averse than they’ve been in decades. Which makes it difficult for nearly everyone but those with sterling credit to actually succeed in getting a mortgage.
A Credit.com reader using the screen name “Von” finds herself caught in exactly this bind. To take advantage of lower interest rates, she and her husband recently applied to refinance their mortgage. But in the process, they discovered an unpaid medical bill that, unbeknownst to them, has been weighing down their credit score.
Now Von faces a conundrum. Her lender says that the couple needs to repay the medical bill, which is in collections, before it will approve her for a new mortgage. But the bill is 42 months old. And in Texas, where Von and her husband live, the statute of limitations on old debts is 48 months.
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“We want to resolve” the collections issue, “however do not have the entire amount” needed to pay off the old bill, Von writes in response to a Credit.com story.
What to do? Begin a payment plan, which will use up money that Von and her husband need for monthly expenses? Or ignore it entirely, knowing that in another six months the bill can no longer be collected anyway?
On the one hand, there is an argument to be made that Von and her husband should ignore the debt. After all, paying the debt off now won’t have any immediate impact on improving their credit score. Rather, it will linger there for seven and a half years after it first went to collections, hurting their score all the while. And making payments on the debt now might hurt the couple’s ability to meet daily expenses or save up for the next big purchase they make, whether it be a new house or another car.
But Von and her husband have lots more to think about than just running out the statute of limitations, says Barry Paperno, Credit.com’s credit scoring expert. One problem is something that the couple has already run up against: their lender is “encouraging” them to clear up this unpaid medical bill before it will approve them for a refinanced mortgage, Von says.
That situation may not change, says Paperno. That’s because the relevant frame of reference here may not be the four years it takes for an unpaid bill to become uncollectible. Rather, it’s the seven and a half years that unpaid bill lingers on a credit report. As long as that unpaid bill remains on the couple’s credit history, lenders may refuse to extend additional credit.
“It has nothing to do with the score,” Paperno says. “Let’s say they take their chances and don’t pay it. The lender or credit card company may still decline them. As long as it’s on there and it’s unpaid, don’t go applying for credit anytime soon.
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That’s assuming the couple makes it through their six-month window unscathed. The collections agency could still sue Von and her husband in court. It could also sell the debt to another, more aggressive collections company, which would have time to sue before the statute of limitations is up.
“They could just come after you tomorrow,” Paperno says.
The judge in the case might side with Von and her husband, or maybe with the collections company. If the company wins, the couple will be forced to pay the debt. But even if the couple wins, Paperno explains, that judgment becomes another negative stain on their credit report, another mark documenting an unpaid bill. And that judgment will linger there for another seven-and-a-half years.
“Even if you pay the next day, right after you receive the judgment, it doesn’t help your score,” Paperno says. “So there is a risk there.”
Von and her husband are right to pause now and weigh their options before moving forward to pay an old debt, especially one she says they did not know existed for more than three years. But adding up all the risks for long-term harm, Paperno says, it’s probably best to tackle the issue head-on and pay the debt if they can.
“Flat out, I don’t like to recommend that someone not pay a debt that they owe,” says Paperno.
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