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Look at full financial picture before paying off an old debt

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Credit Care
'Credit Care' columnist Tanisha Warner
Tanisha Warner is the communications manager for Money Management International, where she manages educational content designed to teach consumers about personal finance topics. She writes "Credit Care," a weekly reader Q&A about debt issues, for CreditCards.com.

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Question for the CreditCards.com expert Dear Credit Care,
I have an unpaid credit card, and I wanted to know if it is better to just settle for paying half or pay in full with interest and late fees? Does it make a difference on my credit history? Thank you. -- Juan

Answer for the CreditCards.com expert

Dear Person,
The majority of the damage to your credit history and score was done when you stopped paying on the account. Regardless of how you decide to pay the account now, the fact that the account went unpaid will continue to negatively affect your credit. With that said, future lenders will want to see that you eventually paid what you owed on the account, in full or in part.

Lenders, landlords, employers and insurers use your credit history as a tool to help determine the risk of doing business with you, renting to you, hiring you and insuring you. So far, we don't have a reliable tool to help us see into the future, so we use the tool we have and that is to review history. We can't know the future, but we can know the past, and the likelihood that a person will default on his or her loan increases if she or he has done so in the past.

A mistake I believe many people make when it comes to personal finance is that they worry more about how a certain action will affect their credit score than looking at how the action will affect their overall financial situation. For example, you ask if you should settle the account for half or pay the full amount. From the narrow perspective of how it would affect your credit, it would be better to pay the full amount. Interested parties would like to see that you eventually made good on your promise to pay and paid all that you owe.

But if you back up and take a look at your entire financial situation, other things should be considered. Do you have an emergency savings cushion (six to 12 months' living expenses)? Will settling the account for half of what is owed cause you to be late on other monthly payments? Are you currently behind on payments to any other accounts? Can you afford the tax bill if the forgiven amount, once you settle the account, is more than $600?

For illustration purposes, let's say you need $5,000 to settle your account and you have the money to do so. I encourage you to take a look at your overall financial picture to determine how best to use the money to benefit your situation in both the short and long term. Settling the account many be the best way to move forward financially, even if it may not be the best move for your credit. Likewise, paying what you owe in full over time may be best. You could then save some of the $5,000 in your emergency savings account and make up late payments on some other accounts if necessary. If you need help sorting through these decisions, consider contacting a nonprofit credit counseling agency.  

However you decide to pay the account, your unpaid credit card account will negatively affect your credit less and less as time goes by and the more positive information you add to your credit report each month.

Handle your credit with care!

See related: How canceled debt can come back as a tax bill

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Published: October 22, 2012


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Updated: 09-29-2016


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