Paying a Debt in Full vs. Settling a Debt

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When borrowers have a loan, they generally have two options: making payments or not paying. When enough payments are made, the borrower pays off both the principal and the interest on the loan until it is paid in full. If the borrower does not pay, the borrower and lender often work out a way to settle the debt through other means, such as a debt restructuring strategy. The lender considers the debt settled if the borrower pays off at least part of the loan and the lender forgives the rest to close the account.

Paying Debt

Paying debt is always preferable when considering a loan. It is fulfilling a contractual obligation to the lender, and it is good for credit. A credit history that shows loans that have been paid in full makes a good impression on future lenders, allowing the borrower to get better loans and rates. Also, paying the debt in full avoids legal actions the lender could take to seize property or demand payment in other ways, leading to court action.

Settle Debt

Settling debt is useful if borrowers can find no other way to keep up on the loan payments. A debt settlement requires that the borrower pay back a large lump sum of the original loan, but cancels the rest of the debt. This has clear benefits for the borrower, but debt is usually only settled if paying has already become a problem. This means that credit scores will suffer due to the late payments or defaulted loan. No borrower should depend on debt settlement to take care of a loan.

Types of Settlement

Debt settlement can be a broad term. Many types of debt settlement involve the lender forgiving part of the debt, but some only move debt and change loan terms to make payment easier. If possible, the borrower should choose the latter option. When a lender forgives debt, it creates a tax obligation. The IRS considers all forgiven debt to be the same as income, and will apply an income tax to it, adding another cost to the process in addition to the common fees associated with settlement.

Paying Debt Quickly

If a borrower chooses to pay off a debt in full, paying off the debt more quickly than the original loan length has its advantages. The faster the borrower pays off the principal, the less interest will be created, effectively lowering the amount the borrower has to pay. While some lenders charge fees for early repayment, others allow borrowers this option. For credit card debt, paying the funds due early can avoid interest altogether.

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