Paid in Full vs. Settled in Full: Which Is Best For Debt?

·6 min read

Dealing with debt can be a stressful and confusing process, especially if you're struggling to pay it down. If you end up with a bill that's past due -- or worse, in collections -- you might be wondering about the best way to handle it.

Two terms you might have seen are having the debt "settled in full" versus "paid in full." "Both options will close the account with a balance of $0 owed," says Colton Castleman, a retirement counselor at Assurance & Guarantee in Burlington, North Carolina. "But they both have different effects on your credit score."

Find out the difference between having a settlement on your credit report compared with a debt that has been paid in full and learn which is better for your finances long term.

[Read: Best Credit Cards for Good Credit.]

Paid in Full Definition

When you make payments on your credit accounts, or fail to do so, the creditor will report that activity to the credit bureaus. The bureaus will then update your credit report to reflect the most recent status of your accounts.

If you have an outstanding debt, one option is to pay off the full amount so your credit report no longer shows it as being due. This is an option even if it's late or in collections. If you choose to pay the debt off, your credit report will note that this account was paid in full.

What it means. Paid in full means the entire principal and any applicable interest is paid back. At this point, you are no longer obligated to make payments.

How it affects your credit. When it comes to your credit score, having a debt that's paid in full is your best option. "Paid in full will have a positive effect on your credit score, and even more so if all payments were made on time," Castleman said. That's because out of all the factors that are used to calculate your credit score, payment history is the most heavily weighted at 35% of the total score. In this case, your account would be considered paid in full and in good standing.

Settled in Full Definition

If you don't have the means to pay off a debt in full, another option is to pursue debt settlement. If you do go through the process of a settlement and complete your agreed-upon payments, your account will be considered settled in full -- or sometimes "paid-settled" -- by your creditor and the credit bureaus. It will be noted as such on your report.

What it means. "Settled in full" is code for a debt that has been paid for less than the entire balance, says Andrew Latham, a certified personal finance counselor and the managing editor of SuperMoney.com. "In other words, it means you did not pay your debts in full."

Debt settlement involves working out an agreement between you and your creditor or a debt collector to pay less than you currently owe but still have the debt considered satisfied. Usually, creditors only agree to debt settlements if you're significantly behind on payments and it's unlikely they will be repaid the full amount. You can negotiate a debt settlement on your own or hire a company to negotiate on your behalf. Your credit reports will show the outstanding debt as settled in full once it's repaid.

[Read: Best Debt Settlement Companies.]

How it affects your credit. According to Latham, a "settled in full" status on your credit report is preferable to "unpaid" or "in default," but it's not great. Settling an account rather than paying it in full and on time signals that you're a risky borrower, which will be reflected in your credit score. Additionally, working with a debt settlement company often means halting payments to your creditor in order to gain negotiation leverage. This can damage your credit leading up to the settlement because you end up with a history of missed payments over many months.

Because so many different things affect your credit score, there's no way to know exactly how much your score will go down if you have a "settled" status on your report. It will certainly reduce it, though. The good news is that while a settled debt will remain on your credit report for seven years, its impact on your credit score will decrease over time.

Paid in Full vs. Settlement on Credit Report: Which Is Better?

Paying off a debt on time and in full is the best option. "It's usually better to pay in full if you can afford it," Latham says. Having a loan paid in full in your credit history helps boost your credit score. Plus, if you didn't miss any payments, your account is considered in good standing, which stays on your report longer than delinquencies -- up to 10 years instead of seven.

Of course, life happens, and you may not always stay current on your payments. Maybe you experienced a medical emergency or job loss and had to rely on credit cards or loans to get by. Perhaps you missed some of your payments along the way. Even if you've fallen behind, you're still better off paying the debt in full.

"In that situation, you will first want to talk to the lender and see if you can renegotiate the terms of the loan," Castleman says. For instance, you may be able to work out a modified repayment plan that extends your loan term and lowers the monthly payment. "You can also speak to them about forbearance to postpone or reduce the payments for a period of time," he adds.

However, if these options aren't possible, debt settlement may actually be your best course of action. Having a debt settled in full is better than continuing to struggle and missing more payments, harming your credit score even further.

Another benefit to settling your debt is reducing the total amount of outstanding debt you still owe. Lenders want to see that you aren't overly reliant on borrowed funds, so maintaining a low credit utilization ratio -- the amount you owe compared with the total amount of credit extended to you -- will help boost your score. In fact, "amounts owed" is the second-most heavily weighted factor in your credit score calculation, making up 30% of your score. By paying down one of your debts, even if it's through a settlement, you lower your credit utilization.

Consider debt settlement if one of these warning signs from Latham applies to you:

-- You don't qualify for a debt consolidation loan.

-- Your balance is more than half of your annual income.

-- You can't afford to pay it off within five years.

[Read: Best Debt Consolidation Loans.]

In some cases, it may be possible to have your creditor report a settled debt as paid in full. This requires some negotiation on your part, and the creditor has no obligation to do so. However, if your debt is reported as paid in full instead of settled in full, you can avoid having that negative mark on your credit report and subsequent hit to your credit score. If your creditor agrees, be sure to get it in writing, along with the date the account will be reported to the credit bureaus as paid in full.

Casey Bond is a seasoned personal finance writer and editor. Her work has appeared in a number of major national publications including U.S. News & World Report, Yahoo Finance, MSN, The Huffington Post, Business Insider, Forbes and others. Follow her on Twitter @CaseyLynnBond.

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