Is It Better To Pay Off Debt Or Settle It? (2024)

When you have past due debts, you may be looking for solutions to pay it off or help avoid a creditor lawsuit. Paying off collectors in full is one option, but you may also consider settling unpaid debts.

A settled debt simply means that a creditor has agreed to accept less than what’s owed as final payment. There are companies that offer debt settlement or debt relief services, and it’s also possible to work out a settlement with creditors yourself.

Should you settle for less or is it better to pay in full? Here are some of the most important things to consider when coming up with a strategy for managing your debts.

Is Paying in Full or Settling Better for Credit Scores?

Your credit scores matter because they determine how easily you’re able to get approved for new lines of credit. They also influence the interest rates you pay and your total cost of borrowing.

In terms of how settling debts versus paying them off affects credit scores, there is a difference. Generally speaking, having a debt listed as paid in full on your credit reports sends a more positive signal to lenders than having one or more debts listed as settled. Payment history accounts for 35% of your FICO credit score, so the fewer negative marks you have—such as late payments or settled debts—the better.

One thing to keep in mind is that creditors may not be willing to discuss debt settlement until an account is significantly past due. So, you may need to be 90 to 180 days behind on your payments before a creditor may be willing to settle for less in lieu of charging off the debt altogether. If the creditor is reporting those late payments to the credit bureaus, then those late payments have already done their damage.

Late payments can linger on your credit reports for up to seven years, although their impact on your scores does fade over time. A settled debt status could add to the negative impact, at least in the near term until those accounts age on your credit reports.

Also, note that paying a collection account in full may or may not help your credit score. That’s because different FICO credit scoring models treat collection accounts differently, based on whether they’re paid or unpaid.

Older FICO versions that were released prior to FICO 8, for example, treat all collection accounts as a negative item. FICO 8, 9 and 10 ignore smaller collection balances under $100 and any collection accounts that are paid in full. Unpaid medical collections are still factored into your score with these FICO versions, but they have less impact for FICO 9 and FICO 10 calculations.

Can You Pay to Delete Bad Debts From Credit Reports?

When exploring options for settling past due debts, you may come across references to something called pay to delete or pay for delete. This tactic involves paying creditors or collection agencies to remove negative information from your credit reports.

It usually involves writing a pay to delete letter to the creditor or debt collector, outlining your risk. If the creditor agrees, you’d pay whatever fee they request and, theoretically, the negative information would be removed from your credit reports.

There’s just one problem with writing a pay to delete letter. When negative information, including settled debts or collection accounts, is accurate, only time can remove it. Pay for delete isn’t an option and it may even be construed as illegal. Again, accurate negative information can stay on your credit reports for up to seven years. So, whether you pay in full or negotiate a debt settlement—either on your own or by engaging a debt settlement company—there’s no way to make negative marks associated with those accounts simply disappear.

How to Settle Credit Card Debt

If you believe debt settlement is the best option for your situation, settling debts yourself can save you money. That’s because debt relief or debt settlement companies may charge a steep fee for their services.

Also, whether you take the DIY route or use a debt settlement company, you may face an income tax liability. If you reach a settlement and at least $600 in debt is forgiven, you’ll likely be required to pay income taxes on the forgiven amount.

Learning how to negotiate credit card debt yourself simply means knowing how to strike the right bargain with your creditors. There’s no set rule of thumb when it comes to knowing what to offer as a debt settlement. Some creditors may refuse anything less than 75% or 85% of the balance due, while others may be willing to accept 50% of what’s owed or even less.

When deciding how much to offer for a debt settlement, consider:

• How much is owed on the debt
• When the last payment was made and how close the debt may be to being charged off
• How much you can realistically afford to pay toward a settlement

That last part is important, as debt settlement usually requires you to make a lump sum payment. Some creditors may allow you to break it up into two or three payments in the case of larger debts. But this still means you’ll need to have cash on hand to settle with.

When you’re ready to make an offer, you can contact your creditor by phone or in writing. Sticking with written communication, whether it’s certified mail or email, means you have a paper trail if the creditor disputes the settlement terms later. Be prepared for your creditor to make a counteroffer but don’t allow yourself to be rushed into agreeing to a number you can’t afford to pay or don’t feel is reasonable.

Once you and the creditor have worked out an agreement, get the final details in writing before sending payment. Your creditor may ask for a wire transfer, check or ACH payment. Once payment is sent, get written verification from the creditor that it’s been received and applied to your account. The last step is following up by checking your credit reports to make sure the account has been properly marked as settled and closed on your credit reports.

What to Do If You Want to Pay Off Debt Instead

If you’d rather avoid a debt settlement, consider your options for paying off what you owe. For example, you could try a structured debt payoff, meaning you and the creditor agree to specific terms on how much you’ll pay each month. Your creditor may be willing to offer a restructured payoff plan if you’ve experienced a financial hardship or you’ve shown that you’re committed to repaying what’s owed.

You can also look into options for making your debt less expensive. If you have high-interest credit card debt, for example, transferring it to a 0% APR balance transfer card could save you money. Just keep in mind that you’ll have to pay the balance in full before the promotional period ends and before the regular variable APR kicks in to avoid interest charges. And you may also pay a balance transfer fee, depending on which card you choose.

A debt consolidation loan is another option. Debt consolidation loans allow you to pay off multiple debts and then make one payment to the loan going forward. A debt consolidation loan or personal loan could make sense for paying off debt if you need to borrow a larger amount of money and if you can qualify for a lower interest rate.

You could also use a home equity loan to pay off debt, though there is a caveat. Home equity loans and home equity lines of credit (HELOCs)use your home as collateral. If you default on the home equity loan or HELOC, you could risk losing your home to foreclosure.

When to Get Help With Your Debt

If you’re overwhelmed by the thought of trying to pay off debt or how to negotiate credit card debt settlement yourself, talking to a credit counselor can help. Nonprofit credit counseling agencies provide a number of services, including helping consumers figure out the right strategy for paying off debt.

A credit counselor or debt counselor can look at your debts, income and spending to help you create a realistic budget. They can also discuss different options for debt repayment, including whether a debt management plan (DMP) might be right for you. This debt payoff strategy involves making one payment to the credit counselor, who then distributes the payment among your creditors.

Debt management plans can save you money if your credit counselor is able to negotiate interest rate reductions or fee waivers on your behalf. Even if you end up choosing a different solution, credit counseling services can help you weigh all the options and get a handle on your debt.

Bottom Line

When you find yourself with a major debt burden, figuring out whether to pay it off or settle it is a big decision. Being overwhelmed by debt can make you feel as if your options are limited; in fact, you have a full range of options—from debt consolidation, to debt management, to debt settlement—as well as resources that can help you, including debt counselors. By looking carefully at your debt and your available options, the best choice will become clearer.