There is a great deal of mystery surrounding the exact formulas used in credit scoring but ask any experienced Loan Officer and he will tell you this much: paying off a collection is usually not the best way to improve your credit score. In fact, paying off an old collection may reduce your score.
On the surface this doesn’t make much sense. Why would an individual with a balance reporting for a collection on his credit bureau be assigned a lower credit score once he paid off that balance? The key to understanding this is in the fact that credit scoring considers the derogatory event (in this case a balance on a collection) and the timing of that event. Both of these factors combine to impact your credit score. In and of itself, a zero balance on a collection will be better for your credit score than an unpaid collection, but when you pay it off, the credit bureau “updates” and reports it as a more recent derogatory event. As an example, a $500 balance on a collection five years old would be preferred to a zero balance on a new collection. The recency of the event is more important than the event itself.
It should be noted that Fair Isaac disagrees that paying off a collection results in recent activity on an account.