Settling a debt instead of full payment may seem as a very lucrative option. But it is important to understand the pros and cons of both solutions before taking any decision. Debt settlement means that you make a one-time lump sum payment against a due credit instead of making the full payment. For example if a person owes Rs. 1 lakh to a credit card company and has not been able to pay the due amount for many months now; the credit card company may make an offer to accept Rs. 75,000 as a lump sum payment against the debt and cancel the remaining due amount. Debt settlement is possible only on unsecured loans, like credit card bills where no collateral is associated (unlike car loan or home loan). A credit company resorts to debt settlement because it is better to have some recovery in one time payment, instead waiting and not receiving any payment at all.
Role of collection account
Settling the debt for less than what you owe may sound attractive, but this immediately opens a collections account in your name. Typically when you agree to settle a debt, your credit card company forwards your dues to a collection company. In effect, this collection company pays your credit card company and now, you owe the settlement amount to this collection company. A collection account, if reported to credit bureaus (and almost always it gets reported) reflects very badly to your cibil score. It simply means that you have almost defaulted on a previous debt and it had to be settled. This may not be very big concern for credit companies giving secured loans i.e. loans against collaterals which can always be confiscated if you default, but still it says something bad about your creditworthiness.
Effect on Credit Report
Settling a debt always reflects badly on your credit report. But imagine the scenario, where months of overdue payment have already made negative impact on your credit report. A new collection account in such case, may not really be a bad idea, where at least it helps you get rid of a debt and start afresh. It is important also to note that settling the collection account on time does not have any positive impact on credit report, whereas settling a debt in full payment will definitely increase your creditworthiness.
If you are planning to take a loan in future (like car loan, home loan etc.) you should avoid any debt overdue situation in the first place, to keep your credit score high. But still, if you have landed in a situation where you have an option of debt settlement or full payment, it is better to avoid the extra negative impact of a collection account and settle the amount in full.
Important points to note in debt settlement
1. Getting the settlement agreement in written and signed is absolutely important. It should clearly state that your previous debt will completely dissolve with the settlement amount.
2. Settlement amount is a matter of negotiation. The larger the amount you owe, the more the credit card company many be eager to settle your debt.