According to Experian, “Settling a debt means that you have negotiated with the lender, and they have agreed to accept less than the full amount owed as final payment on the account.” When this occurs, the credit agencies will be notified that the account has been “settled” or “account paid in full for less than the full balance”.
The pros of paying off a debt in full:
- Your credit score could increase as your credit utilization decreases. Since the debt has probably negatively impacted your payment history (and possibly other credit score factors), your score won’t immediately shoot through the roof. However, over time, if no more debt is accumulated, you should see your score rise.
- You’ll have less stress in your life. Paying off debt can sometimes feel like a huge weight has been taken off your shoulders. You’ve thought about it… worried about it… wondered what to do about it… And now it’s gone. Whew. Feels good, right?
- A cleaner credit report. Without debt, your credit report will look cleaner to potential lenders down the line. Yes, the report will still show “issues” paying off the previous debt, but since the debt is paid off in full, lenders can’t say you didn’t fulfill your ultimate responsibility.
A con of paying off a debt in full is that the money you used to pay off the debt can’t be used elsewhere. If you want to save, invest or spend the money on education, you’ll have to wait until you start to build up more resources. You’ll have to make the decision which is more important to you: using the money for something else or paying off debt. This can sometimes be a very difficult choice.
The pros of settling debt:
- Your credit score damage decreases as your credit utilization decreases. Notice the difference between the heading of this paragraph and that of #1 above. This paragraph heading doesn’t mention an increase in your credit score. It does, however, get rid of any lingering score damage caused by having accounts with high credit utilization. So although it does help stop more score damage from occurring, settling debt most likely won’t increase your score.
- Lower monthly payments. Since your debts will be “settled”, you will pay less than you initially owed on the account. Sometimes, the amount you’ll pay can be 50% less than you were paying for the original debt – saving you money down the line.
The cons of settling debt:
- Additional Fees. While negotiating your settlement, most debt settlement companies request that you stop making payments. This adds up to more late fees, interest and other potential penalties.
- Time Period. Debt settlement can take anywhere from one to three years – that’s 12 to 36 months of additional fees listed above.
- Credit Score Impact. Settling debt, like charging-off it off, is seen as derogatory. It will have a negative impact on your credit score – as will missing payments while negotiating the settlement.
- Credit Report Impact. The fact that your account(s) was settled and that you didn’t pay the full amount, remains on your credit report for 7 years. This could make it more difficult to get future credit from lenders.
- Tax Consequences. Yes, the IRS is on the lookout for those who have settled accounts. Why? They can count the “forgiven” money as income and require you to list it on your taxes.
There are other cons to debt settlement, but these are the primary ones to keep an eye on when deciding whether to settle or pay off your debt. Once you weigh the pros and cons for each, weigh them again – you want to make sure you make the right choice.
Check out myFICO forums to see how others have handled debt settlement (or debt pay off). You might find some good advice or important information to help you with your decision.