Small Debts Can Lead to Big Credit Score Problems

Huge financial obligations are hard to forget or ignore, but those small sums? They can easily slip underground. For a while.

Little liabilities, though, can be as lethal to a credit rating as larger ones -- when they go unpaid.

According to the credit reporting agency Equifax, almost 200,000 of today's credit files contain collection accounts for amounts of less than $100. Many people discover them at the worst possible time, too, such as when they're shopping for a mortgage, vehicle loan or credit card. Have one on your record and good terms vanish, as lenders hike up interest rates or back off entirely.

Don't let minor bills turn into major trouble. Read on for tales of just how harmful such tiny debt bombs can be, and the ways experts say you can diffuse their damage.

Little Debts can Lie in Wait

A common reason people fail to pay affordable bills is that they never knew about them. When amounts are nominal, some creditors don't make sufficient effort to track the person down.

Such was the case for Oakhill, Florida, resident Mike Arman. A wayward $23 lab fee was all it took to poison his otherwise healthy credit report.

It began with a trip to an emergency room for an eye problem. After being treated, Arman paid what was due and moved on. Two years later, he pulled his credit report to find the previously unknown debt in collections.

After some digging, Arman discovered that the original statement had been sent to an incomplete address.

"Instead of picking up the phone and talking to me or even checking my records for my right address, off it went to a local collection agency!" Arman says.

Paula Smith of Walnut Creek, California, also suffered the effects of a mailing mix-up after charging about $100 to her credit card at the department store Mervyn's.

"Before I realized it, the cashier used an old address from my driver’s license as my billing address," says Smith, who attempted to fix the issue before moving abroad for a few years. Chaos set in when Mervyn's filed for bankruptcy protection in 2008 and shifted all unsettled accounts to third-party collectors.

Upon her return to the United States, Smith faced the severity of the damage.

"It messed up our good credit right before we were buying a home," Smith says.

Even after paying off the debt, she had to accept a mortgage with less-than-advantageous terms.

Other consumers deliberately disregard sub-$100 liabilities in favor of paying what they believe are more pressing accounts, says Gail Cunningham, spokeswoman for the National Foundation for Credit Counseling.

"They think the consequences of nonpayment of a small bill are not as severe as those of neglecting payment on a larger debt," Cunningham says. "This could be their logic if money is short and they're having to stretch their dollars."

Credit reports: Delinquent is Delinquent

Not all micro bills gone bad make their way to a consumer's credit report -- but many do. It all depends on what the original creditor wants, says Mark Schiffman, spokesman for the Association of Credit and Collection Professionals.

"You could owe $3 for a movie rental," Schiffman says. "If the collector is working on behalf of that company and they demand it be reported, that's what they'll do."

Schiffman stressed the difference between an agency that collects in the interest of other businesses and one that buys the debts outright.

"When collectors are contracted to work for a company, they must do what the client wishes," Schiffman says. "That may be to file a lawsuit or it may be placing the account on a credit report."

In contrast, when companies sell accounts to third-party agencies, the buyers own it completely and determine what happens next. They can send data about debts of any size to the credit reporting agencies as long as they follow such federal laws as the Fair Debt Collection Practices Act, which stipulates how they communicate with debtors, and the Fair Credit Reporting Act, which (among other provisions) limits the amount of time negative information may be listed on credit reports.

This doesn't mean that the collectors will notify all three agencies -- Transunion, Equifax and Experian -- of the miniature debts. That depends on just how much they want to spend. Each CRA charges a fee to supply information, so the collector may decide to report to just one or two to save some cash.

So at what point do such small debts ding your credit report? If the bill was for something such as a doctor or utility bill, the answer is: whenever it goes to collections. But for a credit card, it's with the first missed payment. Each subsequent skip will worsen your rating. Eventually, the issuer will charge the account off and sell it to a collector. If they choose to report, their involvement will also be evident -- and your scores will really take a hit.

The big effect of a little debt Credit scores such as the FICO, which ranges from a low of 300 to a high of 850, are based on the financial information found on a credit report. Payment history is the weightiest factor, so if a bill was paid late or went into collections, those numbers will suffer.

"A small debt that's reported to a collector or written off impacts a score dramatically," Schiffman says. "You can go from a 750 to a 550 in a millisecond."

A newer version of the score -- the FICO 8 -- excludes debts in collections that are $100 or smaller. But lenders aren't required to use the updated version, and many don't.

Jennifer Barbera, Houston branch manager for the AnnieMac Home Mortgage lending company, says she sees the devastating effect of these seemingly innocent little debts.

"I have a gentleman right now who is in the process of having a home built, and his updated credit report revealed a $65 medical collection, which dropped his score by 50 points," says Barbera.

It's not about how large or small the collection bill is, Barbera says, but how recently it's been reported to the credit agencies: "Once it's 12 months old, it goes into another bucket and is less important, and so on and so forth."

Even if the account didn't go to collections, the scoring impact for a late payment is the same whether the dollar amount is large or small. "The dollar figure of the payment inconsequential," says Barbera. Late is late, and if you are, you'll get penalized.

What to Do About It

Unless you're getting collection calls and letters, you may be unaware of these mini accounts. An October 2013 survey conducted by TransUnion found that a third of Americans have never accessed their reports. That's where you'll find missed payment records of all sizes, so check your credit reports now via annualcreditreport.com.

Spot a little debt on your report, but it's incorrect? Dispute the credit report line item. If it's caused by a mix-up, you can still undo damage with a fight.

"Keep screaming," Arman advises. Because of his mortgage broker background, he recognized the gravity of his $23 situation. Though his debt did legitimately go to collections, it was not his fault.

"We did nothing wrong -- they made a mistake in mailing," Amran says. He sent the collector a certified check and after considerable -- and heated -- back-and-forth communications, achieved success.

"The collection agency wasn't very cooperative until I threatened a lawsuit against them and another against the hospital," Arman says. "Eventually, they decided that they really could delete the entry."

Conversely, if the delinquent debt is accurate and it's young enough to be wrecking your rating, pay it off in full. The mark will remain on the report for seven years, but bringing it down to zero will increase your scores and improve the way lenders and other businesses view you as a borrower today. Even better: Chances are you can afford it.