When you break this down, that's over $18,500 of debt for the average household--without a mortgage. In fact, about 43 percent of families spend more than they earn each year, and the average household has $8,000 in credit card debt alone.



Accounting 101

The equation seems relatively simple. Spend more than you earn, and you accumulate debt. When you have more money coming in (or fewer expenses), you put that money toward paying off your debt, your credit score improves, and all is well.

In reality, however, it's not nearly this simple. Creditors and collection agencies are sneaky, and there are all kinds of games going on that complicate the process of getting out of debt. Morally, it may be the right thing to pay off an old debt, no matter what, but financially, this is not always the case. Here are several circumstances when paying off a debt can actually hurt your credit.

Statute of Limitations

Every state has a statute of limitations that limits the amount of time a creditor has to sue you for a delinquent account. This can range from three to 15 years, but generally most states set it at five or six years. However, it is possible to accidentally extend the statute of limitations just by calling a creditor to inquire about an old debt, or by acknowledging that the debt is yours. These rules vary by state, so be sure to find out your own state's laws on the matter.

Another useful bit of information is that bad marks on your credit report can only be reported for 7.5 years (10 years for bankruptcies). After that, they fall off your record, so paying off the debt won't affect your credit score.

Charge-Offs: When it's Beneficial to Pay Up

After six months of no payments, a creditor can write off your account as a bad debt. This is called a "charge off," and is bad news for your credit score. The creditor will usually then turn the account over to a collection agency, and you'll have two separate entries on your credit score for the same debt.

What really matters for your FICO credit score (the one used by most lenders) is what the original creditor entry says. If your entire balance is there, paying off the collection agency and then contacting the original creditor to zero out your account may improve your credit.

But, if the original creditor entry shows a zero balance (because it was transferred to collections), which is often the case, there will be no improvement to your credit score--even if you pay off the debt.

Settling Old Debts

While settling an account for less than what was originally owed may seem like a good idea, and will appease the creditor, it can actually hurt your FICO score.

"Settling the account can add a new element to its record at the bureau. Since that element's date would be more recent than the original item, it can end up lowering the score," said Craig Watts, spokesman for Fair Isaac Corp., the creators of the FICO credit scoring system.

In this case, it might be better to leave the account open and unpaid. Further, if you do settle, another collection agency may still contact you and try to collect the unpaid portion. Or, the collector could tell the Internal Revenue Service that you've received "income" from the settled debt--income that you'll owe taxes on.

Paying on Old Debts

The more recent the debt, the greater its impact on your credit score. If you have an old debt, then decide to make a payment, it could update the delinquency, making it look more recent. The end result? A lower credit score.

If you want to know more, the Federal Trade Commission has a brochure that outlines the basics of fair debt collection and consumer rights that everyone needs to know.