Paid in Full or Settled: Which is Better?

If you have credit card or consumer loan debt, there are typically two ways to get rid of it: pay in full or settle. If you can afford to pay your credit card debt in full, it is a better option than settling. While both strategies will result in your account closing with a balance of $0, your credit score is affected differently depending on the option you choose. 

What Does it Mean When You Settle?

Settling your debt involves negotiating with your creditors to pay off an amount that is less than your original balance using a lump sum payment. Typically, creditors will only agree to participate in debt settlement if you are very behind on your payments and unlikely to pay back the full amount. A creditor may agree to settle for less than the full amount because they would rather you pay them something as opposed to nothing. 

When it comes to how you settle, you have the option to negotiate with your creditors on your own or, you can work with a debt settlement company who will negotiate on your behalf. Before working with a debt settlement company, make sure you ask about their fees and look into their credentials. Many debt settlement companies charge a significant amount of money without any guarantee of success. Your creditors are not required to work with them or accept any settlement offer. When you are already in a tough financial situation, the last thing you want to do is pay a high fee to a debt settlement company that isn’t able to settle your debt. But, this does happen. 

Be aware that settling your debt will have a negative effect on your credit score. It will show up on your credit report for six years and indicate to future lenders that you have a credit history of not paying back your entire debt. 

Benefits of Settlement

While having to settle your debt is not ideal, if you are struggling financially and are unable to pay off your debt in full, it is a solution to consider. Some of the potential benefits associated with settling your debt include:

Reduce the total amount owed

If you can negotiate a settlement with your creditors then you can end up paying less than the original balance owed. This can help you to save money. 

Improve debt-to-income ratio

Settling can also improve your debt-to-income ratio which can help to improve your credit score.  

Fewer missed payments

Settling can potentially prevent you from racking up a series of missed monthly payments. 

Better than defaulting

Settling your debt is typically a better solution than simply not paying your debt at all. 

What Does it Mean When You Pay In Full?

When you pay off your debt in full it means you pay off the entire balance of your credit card or loan. This includes the principal, interest payments, and any late fees. Creditors prefer when you pay in full because they get the total balance back rather than settling for less. 

Paying in full is also better for your credit score. When you pay in full this brings your account into good standing and can help to improve your credit score. Of course, if you’re experiencing difficult financial times it may not be possible for you to come up with enough money to pay in full. 

Benefits of paying in full 

There are several benefits associated with paying your debt in full, including: 

Positive impact on payment history

Paying your bill in full can help to improve your credit score as payment history accounts for 35%.

Positive impact on credit utilization ratio

Paying your credit card in full can also have a positive impact on your credit utilization ratio – the amount of available credit you are using. When you pay off a large sum of money, this decreases your credit utilization and makes you appear like you can manage your credit responsibly. 

Avoid paying interest

The faster you can pay off your debt in full, the less you will have to pay in interest. 

What's the Difference Between Settle in Full vs Paid in Full?

The main difference between settling in full versus paying in full is that you don’t pay your entire balance when you settle. Instead, you pay the agreed-upon amount that you’ve negotiated with your creditors. 

Another important difference is how your credit is affected by each strategy. Settling has more of a negative impact on your credit than paying in full. When you settle, this shows up on your credit report and signals to lenders that you have a history of not repaying the full amount of your loan. This can lower your score and will stay on your credit report for six years. 

When you pay in full, it shows up on your credit report that you have paid off your entire loan. 

What Happens If I Don't Pay At All?

If you simply don’t pay your debt, this can result in default. For instance, if you are more than 30 days late making a payment on a credit card it becomes delinquent. At this point, your issuer may report the late payment to the credit bureaus. Then, after a period of around 120 to 180 days, your issuer can close the account and charge it off.

When the account is “charged off” your account is closed and you can no longer make any charges. Your issuer might sell your debt to a third-party collections agency or debt collector. You are still obligated to pay this money but now you have to pay the collection agency instead of the original creditor. Defaulting on your debt can have a far-reaching impact on your ability to borrow money. A default typically stays on your credit report for six years. 

Should I Pay in Full or Settle?

If you can afford to pay your debt in full, this is typically the best option. Having a “paid in full” on your credit report looks better than having a settlement. However, if you are in a situation where you simply can’t afford to pay back your debt in full, debt settlement can reduce the total amount you need to pay and is a better option than doing nothing.  

Are There Other Payment Options?

There are other payment options you can consider, including: 

• Debt consolidation. This involves paying off multiple debts with one large loan. There are several ways you can do this. For instance, you can take out a personal loan and use it to pay off higher interest debts. Or, you can look at using a balance transfer credit card to move balances from high-interest cards to a new card with a lower rate. To qualify for a consolidation loan and get a reasonable rate, you will need a good credit score. 

• Credit counselling. You can work with a credit counsellor who can provide tips on how to deal with your debt (e.g. budgeting or designing a payment plan). A credit counsellor can also help you to build a debt management plan where they contact your creditors to see if they are willing to reduce or eliminate the interest on your debt. Though, your creditors do not have to agree to this.

• Consumer Proposal. A consumer proposal is a government debt relief program. In your proposal, you can ask to reduce the amount you owe or increase the timeframe in which you have to pay back the money. Unlike debt settlement or credit counselling, a consumer proposal is a formal, legally binding process that can only be administered by a Licensed Insolvency Trustee (LIT). 

• Bankruptcy. This is also a legal process conducted by a LIT. Like debt settlement, you will not have to pay back all of your debts in full and this process can provide you with a fresh financial start. However, it will stay on your credit report for up to seven years after you file and you may have to give up some of your assets.

The Bottom Line

If you are financially able to pay your debt in full, this is the best option. If you can’t afford to pay in full, debt settlement can help to reduce the amount you owe and is better than simply not paying your debt.