Debt settlement undeniably offers a huge financial relief and it just lifts all the debt burden off your shoulders. However, what comes next is more important and crucial for your financial future. Sometimes, people take out personal loans to pay off their previously settled debt for various reasons. Some take this decision in order to improve credit, some due to their lingering obligations and for some, this step is important just to clear their records.
Now, before you take such a crucial decision, it’s best if you first weigh out all of its pros and cons. You need to be sure that it’s just the right move that you are making and it will have a positive impact on your finances.
Debt Settlement Vs Paying In Full-What’s Better?
For starters, you should know what debt settlement is. It’s a negotiation between you and your creditor where you agree to pay a lump sum of the total amount you owe and in return your creditor just waives off the rest of the debt. In a nutshell, debt settlement means that you pay your creditor less than what you owe and your account is then “Settled”.
A “settled” debt will stay on your credit report for 7 years and it can significantly lower your credit score. On the other hand, “paying in full” is always the better option because it does less damage to your credit and is more favourable.
When And Why To Consider A Personal Loan After Settlement?
As said earlier, taking up another personal loan after you’ve recently settled your account is a decision that you must think about properly. If it does seem to fix your financial situation and if it’s something you can afford, only then you should make this move.
Here’s when taking a personal loan after settlement is a good idea;
1-When You Have To Improve Your Credit Report
When you take up a personal loan after debt settlement to pay off your settled debt (in case the creditor allows it) can work wonders for your credit status. Paying it off means your account’s status on your credit report will automatically be updated to “paid in full”. Mostly in such cases, creditors and collection agencies are open on how they’ll report the account if you pay them the rest of the amount. A “paid in full” status means more creditworthiness and eventually it will have a very positive impact on your overall credit report.
2- When You Have To Simplify Your Finances
If you are dealing with multiple settled accounts and remaining partial payments then taking up a personal loan to consolidate all your debt is a good decision. It will just make the monthly payments more manageable for you and eventually, it’ll help you stay more organized without any more missed or late payments.
3-When You Want To Avoid A Lawsuit
If your settlement is “verbal and informal”, it means that your creditor can still take a legal action against you at any moment and your fees and interest might keep piling up. To avoid a lawsuit, it’s important that you either settle the debt in writing or if your creditor doesn’t agree to it then you just take up a personal loan and pay off your outstanding balance immediately.
The Downside Of Using A Personal Loan
Every financial decision you make will somehow have a downside to it and the same is the case with taking a personal loan to pay off your settled debt. You just have to weigh out the positives and the negatives to ensure that you are making the right move.
1-You Might End Up Paying More Than What You Agreed To
If you’ve already settled your debt with your lender, it means that he has agreed to forgive a portion of your debt but you are still trying to pay off the forgiven amount using a personal loan. In simpler words, you’ll be paying voluntarily even when you aren’t legally obliged to do so.
2-Credit Score Improvement Isn’t Guaranteed
If your account has already been marked “Settled” and it has been closed then know that the damage has been done and you can’t really do anything about the credit impact. Even if you pay the balance in full, there’s no guarantee that your creditor will report it as “paid in full” and hence you can’t really tell if your credit score will improve or not.
3-Additional Burden Of Debt
Taking up a personal loan means more debt and more stress. Especially if you are already on a tight budget and don’t really have a stable income then it’s best to avoid any more debts or else you’ll be dealing with a lot more financial problems than before.
4- Tax Implications Have Already Been Incurred
If your creditor has forgiven more than $600 of debt then you’ve probably received the income tax bill. The IRS considers the forgiven amount as taxable income. Now even if you pay the debt in full after settlement, it won’t really reverse the tax and you’ll still have to deal with it.
The Best Alternatives To Consider
Opt For Credit Repair Service
Instead of paying the settled debt, you should try working with a credit repair service instead. In case of any inaccuracies, you should dispute them with the credit bureau or negotiate making updates to your credit report.
Negotiate With Your Creditor
If you are really set on repaying your settled debt due to personal or moral reasons then it’s best if you talk to your creditor and ask him for a “pay for delete” status. You should have a clear status update before you send any money.
Use Secured Credit Building Cards
Instead of taking another loan and dealing with the monthly repayments again, it’s best that you just opt for a secured credit card or a credit builder card. This move can work wonders for you especially if your purpose of repaying the loan is to improve your credit. In fact, it’s highly recommended that after a debt settlement, you should use a secured card to improve your credit history and rebuild your credit score.
When Does It Make Sense?
The only situations where using a personal loan to pay off your settled debt make sense is when;
- You have a written confirmation from your creditor that after the payment, he will update your account’s status as “paid in full”.
- The debt wasn’t legally settled and you still do owe the outstanding balance to your creditor.
- You are dealing with multiple old debts and you want to consolidate them to make things more manageable.
- You are financially stable and now you want to improve your credit history by taking necessary measures.
Final Thoughts
Taking out a personal loan to pay off your settled debt isn’t a wrong move but it definitely is a crucial decision and you should take it with caution. Especially if you are already stuck with a financial hardship and don’t really have a stable income then it’s best that you don’t take any such step mainly because legally, you aren’t required to pay the loan off after a settlement. If you still want to do so then you must ensure that the benefits are outweighing the costs.
Before you take any such decision, it’s best if you talk to a financial advisor first. Sometimes, letting the settled debt stay settled is better than trying to clean up the mess again. If your sole purpose is to secure your financial health or improve it then yes, you should take up a personal loan but make sure that you can afford it too. The right answer depends on your current situation and the long term goals you have.
FAQs
Q1. Will Paying Off A Settled Debt Improve My Credit Score?
There’s no guarantee whether this move will improve your credit score or not. Once your account has been marked “Settled”, the damage has already been done. Your credit score will only change if your creditor updates the status of your debt as “paid in full” instead of “settled”.
Q2. Will Repaying My Settled Debt Affect The Taxes I’ve Already Paid?
No. If you’ve already received the 1099-C form by the IRS and you’ve paid the tax then repaying your creditor won’t make any difference in your tax event and it won’t be reversed.
Q3. What’s The Best Way To Rebuild Credit After Debt Settlement?
The best way is to use a secured card or a credit builder loan. Using a secured card will help boost your credit score quickly. You just have to showcase responsible financial behavior, make your payments on time and avoid any more debts in order to see the difference in your credit.
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