You may have a lot of stress if you are carrying around past-due debt. At best, multiple late or missed payments can result in a damaged credit report and a lawsuit at worst. But should you pay a charge off in full or negotiate a debt settlement?
Getting tangled up with charge-off debt can be a tricky situation When an account becomes severely delinquent, creditors may “charge it off” – essentially writing it off as a loss But this doesn’t mean the debt is forgiven. You still legally owe the money, and the charge-off damages your credit.
So if you have the ability to pay, is it better to settle the charge-off for less than you owe or pay it in full? The short answer is: if possible, pay in full. Here’s a breakdown of the pros and cons of each option.
What is a Charge-Off?
A charge-off occurs when a creditor writes off a delinquent account as unlikely to be paid after 180 days of non-payment. This allows them to take a tax deduction for the lost funds. But make no mistake – you still owe the full balance.
Charge-offs devastate your credit since payment history makes up 35% of your score. A charge-off makes it harder to get approved for new credit or loans, and you’ll pay higher interest rates if you do qualify.
The creditor or a collection agency can continue to pursue collection on the charged-off debt through calls, letters reporting it to credit bureaus, or even suing you. It’s critical to address charge-off debts before things escalate.
Paying a Charge-Off in Full
Paying the charge-off balance in full means you’ve paid the entire outstanding amount owed after it was charged off This satisfies the debt completely
Benefits of Paying in Full
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Your credit report will show the status as “paid in full” rather than “settled.” This looks better to future lenders.
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You avoid any potential tax consequences that come with settled debt being considered taxable income.
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Resolving charge-offs quickly can help you start rebuilding credit sooner.
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You eliminate the debt burden completely and avoid further collection attempts.
Drawbacks of Paying in Full
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It can be financially difficult if money is tight.
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Charge-offs stay on your credit report for seven years no matter what. But paying in full looks better than other options.
Settling a Charge-Off for Less
Settling means negotiating to pay a portion of what you owe as payment in full. Collectors often accept settlements since they’d rather get something than nothing.
Once paid, the creditor forgives the remaining balance. Your credit report will list that debt as “settled.”
Benefits of Settling
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You save money by paying a smaller amount compared to the full balance.
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Since collectors agree to settlement offers, it can provide a quicker resolution if you can’t afford to pay in full.
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Settling is still better than ignoring charge-offs and allows you to move forward.
Drawbacks of Settling
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It will likely hurt your credit more than paying in full would.
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Settled debt can be considered taxable income by the IRS for the amount forgiven.
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You still owe the balance until settlement terms are fulfilled.
Which is Better: Settling or Paying in Full?
Paying charge-offs in full is ideal because it looks better on your credit, prevents tax headaches, and lets you resolve the debt entirely.
However, when money is tight, settlement could be a decent option to resolve the situation faster for less money out of pocket. Just be aware of the drawbacks.
Either option is far better than ignoring charge-offs and allowing damage to continue. Unpaid charge-offs lead to:
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Ongoing collection efforts and credit reporting
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Potential lawsuits or wage garnishment
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Credit score decline with no chance to rebuild yet
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Higher interest rates on future loans or credit denial
Tips for Handling Charge-Offs
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Get professional guidance from a nonprofit credit counselor if unsure how to proceed. They can provide advice tailored to your situation.
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Be proactive. The sooner you start resolving charge-offs, the sooner you can begin credit repair.
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If settling, get agreement terms in writing to ensure the collector doesn’t continue pursuing the remaining balance.
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Ask collectors to remove the charge-off from your credit report as part of settlement terms. While rare, pay-for-delete arrangements do happen.
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Make payments on time going forward and keep credit card balances low to offset charge-off damage.
While paying charge-offs in full is ideal, it’s understandable if your financial situation makes settlements the better choice for now. Either option is far superior to ignoring the problem. Seek help from a nonprofit credit counseling agency if you need guidance on the best path forward.
Risks of Debt Settlement
If you want to be free of your crushing debt altogether, you may lean towards acquiring a debt settlement. However, there are financial risks associated with a debt settlement.
If you work with a debt settlement company, you will have to pay service fees. A service fee can be as high as 25% of the original debt amount. If you initially took out a $5,000 loan with bad credit, you will owe a $1,250 service fine!
What Is a Debt Settlement Company?
There are debt settlement programs that promise to erase or reduce the amount of money a borrower owes to creditors. These settlement programs typically cost a small percentage of your outstanding debt, about 15% to 25%. This may sound like an ideal solution if you feel like you are drowning in debt, but it may actually be detrimental.
Debt settlement companies pay creditors in one lump sum payment. However, to obtain the money necessary, a debt settlement program will ask borrowers to set aside a certain amount every month for 36 months or longer. This money is held in a savings account until enough has been saved to pay off a settlement. Unfortunately, many people drop out of debt settlement programs because they cannot afford the required monthly payments.
Many debt settlement programs encourage borrowers to cease making payments to creditors so they can commit to saving money for a settlement. However, this can ruin your finances. Late fees can accumulate, and a debt collector may file a lawsuit against you.
Whats Better For Your Credit Paid In Full or Settled for Less
FAQ
Should I pay off collections in full or settle?
If you can afford to pay off a debt, it’s generally a much better solution than settling because your credit score will improve, rather than decline.
Will settling a charge-off raise credit score?
While paying a charged-off debt won’t directly boost your credit score, exploring avenues to remove the charge-off from your credit report can be worthwhile. Negotiating with debt collectors, correcting inaccuracies, or seeking professional assistance are viable options.
Does it make sense to pay off a charged-off account?
If you have the means, paying off the charged-off account can help improve your credit standing. While it won’t immediately remove the charge-off from your report, it will update the status to “paid charge-off,” which looks better to potential creditors.
Will my credit score go up if I pay off a delinquent account?
If your debt has been sent to a collections agency, paying it off may immediately raise your credit score, depending on which scoring model is being used. Newer scoring models like FICO 9 ignore paid off collections, but older formulas such as FICO 8 do not.