Should I Pay Off Old Debts or Settle Them for Less?

February 16, 2011

2 minute read

Money Girl explains how to pay off old debts or how to settle them off for less.

Q. If I have money to pay off my delinquent debts, should I pay the full amounts owed or negotiate to settle them for less?

A. Having a substantial amount of cash to pay down an old debt puts you in a very good position to negotiate a settlement. Many creditors would rather accept a portion of your debt in cash now, than to wait and possibly receive nothing in the future.

However, there are 3 cons you should consider before cutting a settlement deal:

1. You’ll owe tax on any amount of forgiven debt. When a creditor cancels all or a portion of your debt, they’re required to report it to the IRS. You’ll receive Form 1099-C and must include the amount on your tax return.

However, you may be able to exclude debt on your principal residence that was forgiven from 2007 through 2012. Be sure to read or listen to What You Need to Know About Forgiven Debt and Taxes.

2. Settling a debt doesn’t take it off your credit report. Debts with late payment history stay on your credit report for 7 years from the date you originally defaulted, regardless of whether you settle them or not.

3. Settled debt hurts your credit. A settled debt gets labeled as such on your credit report instead of showing up as “paid in full.” That damages your credit score more than if you had paid it off in full. Additionally, a settled debt may give a potential creditor cause to doubt your future credit-worthiness.

To learn top strategies to boost your credit score fast, download the free Credit Score Survival Kit! This multimedia gift is available for a limited time.

Debt image courtesy of Shutterstock

About the Author

Laura Adams, MBA

Laura Adams received an MBA from the University of Florida. She’s an award-winning personal finance author, speaker, and consumer advocate who is a frequent, trusted source for the national media. Money-Smart Solopreneur: A Personal Finance System for Freelancers, Entrepreneurs, and Side-Hustlers is her newest title. Laura’s previous book, Debt-Free Blueprint: How to Get Out of Debt and Build a Financial Life You Love, was an Amazon #1 New Release. Do you have a money question? Call the Money Girl listener line at 302-364-0308. Your question could be featured on the show.

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