It doesn't make sense--you'd think that by changing an "open" collection to a "paid" collection, you'd improve your credit score. And that's what a lot of folks do before shopping for mortgages with bad credit. But guess what? In many cases, paying off those collections worsens credit scores.
Why would paying off a collection account worsen your credit score?
The problem stems from the age of the collection account, not the fact that you're paying off a debt. Credit scoring is designed so that the most recent transactions are the most heavily weighted, and your credit history (good or bad) has less effect on your score the older it is. So if your collections are a few years old, their effect on your score has been diminished. When you pay them off or start a repayment plan, bingo! They march front and center right back into the present.
It's as if a new collection account popped up. So unless the collections are quite new, your best bet is to leave them alone so your good deed doesn't give you bad credit. Mortgage lenders can (and often do) make paying off a collection a condition of your loan approval, but you can do that at the title company when you close on your home purchase or mortgage refinance.
Paying off a collection doesn't remove it
The other misconception about collection accounts is that they go away when paid off--normally, they don't; they just show that they have been paid off. Just as a credit card account wouldn't drop from your credit report when you close it out, you can't hide the evidence that you had a debt go into collection.
It's a confusing issue
MyFICO says that "paying old collections won't drop your score," and, "we always recommend paying off your legitimate debts." However, the MyFICO forums are littered with folks who say it isn't so--many claim their scores dropped 50 points or more when they paid off old collections. In any event, no one is claiming that paying off old collections helps your score. There is no reason to do it, unless…
Negotiate a burial
The only way to get fast improvement from a collection repayment is to get the collection agency to agree to remove the account from your credit history (with all three bureaus). You want this agreement in writing--explain to them that you'd like to repay the debt but that you can't chance lowering your credit score. If they agree, pay the debt. Understand that the debt collector cannot remove any negative information about your debt that was added to your credit files when the debt was still with the original creditor.
How much you will to pay
How you'll pay (lump sum or over time)
When the lump sum or payments are due
How you will make the payment(s)
That the debt collector agrees to expunge your account from credit reports
Do not sign the agreement until it reflects everything you agreed to and unless you understand everything in it. When the collection agency returns the signed agreement make a copy for your records.
Once you've paid off the collections, have your lender request a Rapid Rescore (only your lender can do this), and your credit score should go up.