Should you pay off debt or settle it?

If you have a lot of credit card debt, you may be wondering how you can pay it off. You can always pay off your balance in full, but you might also be interested in whether debt settlement is a good idea. If you have a lot of credit card debt, you might be wondering how you can pay it off Should you pay off debt or settle it?

In some cases, you can work out a deal with your lender to pay off less debt than you actually owe in exchange for making a single payment. Debt settlement may seem like a good idea (who doesn’t want to save money?), but it can hurt your credit score and isn’t worth the time and effort. Should you pay off debt or settle it?

Read on to learn more about whether it’s better to pay off your debt or settle it.

Should you pay off or settle your debt?
The good news is that you’ll be debt-free no matter what you do: pay off your debt in full or settle it.

Your choice of path will depend on whether you want to protect your credit score or save money first. If you have a lot of credit card debt, you might be wondering how you can pay it off

Paying off your debt can hurt your credit score, but it can also save you money. It’s important to remember that settlement is usually only an option when a lender writes off your debt as a loss, which happens when someone is very late on their payments. You should always pay your minimum debt payments on time. Should you pay off debt or settle it?

If you want to save money by settling, your credit score isn’t completely ruined. Paying off your credit card debt will lower your credit utilisation ratio, which will raise your credit score. The credit utilisation ratio shows how much of your available revolving credit you are using. When you pay off a type of revolving credit, like a credit card or line of credit, you use less credit, which lowers your credit utilisation ratio. If you have a lot of credit card debt, you might be wondering how you can pay it off

You should try to keep your credit utilisation ratio below 30%. The lower it is, the better your credit score will be. Paying off revolving debt is a great way to raise your credit score because your credit utilisation is the second most important part of FICO’s credit scoring model, after making payments on time. Should you pay off debt or settle it?

Paying off your debt in full without settling will cost you more, but it’s the quickest way to get out of debt because settling it takes a long time. Also, waiting for a settlement offer to come through and taking longer to pay off your debt can hurt your credit score even more.

Think about taxes and fees
It’s important to think about how settling your debt will affect your taxes when you decide whether to pay it off in full or settle it. You have to pay taxes on debt that has been “forgiven”. If the amount forgiven is more than $600, the creditor or collection agency you settled with will send you a 1099-C Cancellation of Debt tax form. Should you pay off debt or settle it?

You have to tell the IRS about any amount of forgiveness you get that year because it’s considered income. The money you “saved” through a settlement could end up costing you more than you thought when you add it to your taxable income. You might have to pay fees to settle your debt on top of taxes. It’s important to keep an eye on these extra costs because the value of settling goes down as your savings go down. If you have a lot of credit card debt, you might be wondering how you can pay it off

If settlement is the only way you can pay off your credit card debt, make sure you have enough money set aside to cover the extra taxes.

Things to think about when you settle Should you pay off debt or settle it?
You should think about the status of your debt before you decide to settle it. For example, is it being sent to collections or reported as a charge-off? If you have a lot of credit card debt, you might be wondering how you can pay it off

When a credit card debt is marked as a charge-off
One reason settling can hurt your credit score is that once a charge-off debt is settled, the creditor usually starts reporting the account to the credit bureaus as “settled for less than the full amount due.”Should you pay off debt or settle it?

The score sees both a charge-off and a settled account as bad things, even though the debt has basically been erased.

The length of time since an account had trouble making payments can be one of the worst things that can happen to a credit score. In other words, a new bad item will hurt your score a lot more than an old one. This is why scores usually get better over time after problems are fixed. If you have a lot of credit card debt, you might be wondering how you can pay it off

When a card goes from being reported as a charge-off to being settled, the outcome is better, but the negative item may have a lower score than it did before settling because of the “time since the most recent delinquency” calculations. Should you pay off debt or settle it?

When people don’t pay their credit card bills, they get sent to collections.
A recent debt settlement can hurt your score if it replaces a charge-off as the most recent negative status. However, the last and worst step along this timeline is much easier.

Once a bad debt goes to a collection agency, it won’t “matter” to the score whether the debt is paid in full or settled, according to the most popular FICO models. When a collection goes from unpaid to paid-in-full or settled, there is no change in reporting, unlike when a debt is settled at the charge-off stage. Should you pay off debt or settle it?

It is common for the date the debt was given to the collection agency to be the only one used to determine how recent it is, no matter what happens in the end. If you have a lot of credit card debt, you might be wondering how you can pay it offShould you pay off debt or settle it?

The bottom line
Settling or paying off credit card debt in full has both advantages and disadvantages. When you make that choice, you need to think about the real cost of settling, which includes taxes and fees from the debt settlement company. If you have a lot of credit card debt, you might be wondering how you can pay it off Should you pay off debt or settle it?

Also, think about how the debt settlement will affect your score’s recovery, especially if you’re settling a pre-collection charge-off. Consider each option carefully, and remember that paying off your credit card debt is something to be proud of. Should you pay off debt or settle it?

Editorial Disclaimer

The editorial content on this page is based solely on our writers’ opinions, not their ad revenue. The credit card companies did not give it to us or ask us to make it. We may get paid when you click on links to products from our partners, though. Should you pay off debt or settle it?

Jacqueline DeMarco writes about personal finance for CreditCards.com. She has worked with more than a dozen financial brands, such as LendingTree, Credit Karma, Fundera, Chime, MagnifyMoney, Student Loan Hero, ValuePenguin, SoFi, and Northwestern Mutual, to give readers thoughtful content that helps them understand complicated topics that they probably didn’t learn in school. You can find out more about her work and get in touch with her on LinkedIn or at JacquelineDeMarco.com. She has even been interviewed about her job and running a freelance writing business. Should you pay off debt or settle it?