It’s not uncommon for people in the United States to be under debt. And now, more than ever because o
f the COVID-19 pandemic, the number of Americans in debt is growing.
- 55% of Americans are currently in credit card debt.
- The past decade has seen an 81% increase in auto loans.
- During this same period, student loans have increased by 113%, and currently, 44.2 million Americans have student loans.
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These are just a few types of debt that people are dealing with today. But no matter which kind it is, a common question that debtors ask themselves, “Is it better to pay off collections or settle?”
In this blog, we will discuss both options from a debtor’s perspective.
So let’s get down to business, shall we?
You’ve received a debt collection letter, and now you don’t know what to do. But one thing’s for sure. Your debt can hurt your credit score and your ability to get approval for a loan or a new credit card. The higher the debt, the more it hurts your credit score.
So ideally, if you have the money, you would want to pay the debt in full as soon as possible. It is often the most convenient way to resolve the issue since there are no negotiations involved. More importantly, paying in full allows the collector to delete the account from your credit report.
However, for those who don’t have adequate funds, there is another option – settling.
But let’s begin by understanding what the word means.
Debt settlement is the process of negotiating the debt amount with lenders to reduce the overall debt. In a debt settlement agreement, the two parties agree on a percentage of the total amount that will be paid. Settling is a good choice from a financial point of view when you are low on cash.
When you have decided to opt for a debt settlement agreement, you can reach out to a debt settlement company for assistance, or you can negotiate a settlement directly.
In the case of a debt settlement agency, the process of collecting debt is regulated by state laws. These laws are enacted to protect the rights of the debtors. So, for example, if you are hiring a Dallas collection agency, then they will have to abide by the Texas Debt Collection Act.
However, if you are negotiating a settlement by yourself, then there are different ways to go about doing this, as well.
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Option 1 – Reported as ‘Paid In Full’
A settlement payment that’s labeled as “paid in full” means a portion of the amount was agreed upon, payment was collected, and the creditor agreed to report it as “paid in full.”
It can help boost your credit score because even though you settled, your account won’t show that. This agreement should be received in writing, and the document filed as proof of the settlement.
Option 2 – Reported as ‘Settled in Full’
An account that has been settled and paid will most likely appear as “settled in full.” Any debt that is not paid in full will be labeled as ‘settled.’ It can hurt your credit scores.
A ‘settled’ status can remain on record for seven years from the date the debt was settled. But although settling has negative repercussions, it is typically viewed as more favorable than not paying it at all.
Moreover, as more positive information is added to your credit report, and the debt settlement gets old, it will have less of an impact on your credit score.
Accounts with zero balance, i.e., debts that are cleared, are no longer counted in the newer versions of FICO and vantage credit scoring system. Your credit report will still have the details, but it won’t affect the scoring system.
What can go wrong with paying less?
Besides the immense relief of getting out of debt, there is usually nothing to worry about. However, you need to be aware of common pitfalls that are associated with debt settlement:
- Debt settlement company’s fees
A debt settlement agency’s job is to negotiate a payment on your behalf. While you may be saving money by only paying a percentage of the debt, you must understand that these agencies collect monthly savings contributions from clients.
On top of that, they can even charge a monthly service fee. So before agreeing on hiring an agency, make sure to discuss all the expenses you will have to pay.
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- Government taxes
If you have a debt over $600 and decide to settle, you will have to report the forgiven amount. The Internal Revenue Service (IRS) considers this as a source of income. Guess what? Now you have to pay more taxes.
So before agreeing to settle, do the math. Will you be paying more than you believe that you are saving? If you take this route, then you will also have to fill out the 1099-C Cancellation of Debt tax form.
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While you may feel like a settlement is a great option, make sure of what the implications are in the long run. Some believe that the best way to handle debt is to pay it off in one go.
But no matter what you decide, make sure you verify the debt before you make any payments. Ask the collection agency for written debt validation. Also, keep track of your communications with the collectors, even after the debt is cleared.
Evie harrison is a blogger by choice. She loves to discover the world around her. She likes to share her discoveries, experiences and express herself through her blogs. Find her on Twitter:@iamevieharrison