- advertisement -

Yes, pay off that old debt

Dear Debt Adviser,
I read a previous question that you answered that really helped me concerning "Getting rid of an old charge-off." In my situation, I've been making monthly payments on my charge-off going on one year and now that I have the balance down to a reasonable amount where I can settle for 50 percent, I plan to do that. My question to you is, how do creditors view a "settled charge-off"? Will this help my FICO score? Keep in mind my goal for the year is to be able to purchase my first home. -- Von

- advertisement -

Dear Von,
Congratulations on setting a goal for yourself and working to meet the goal. You will remember your first home purchase for the rest of your life.

Your question of how creditors will view your "settled charge-off" is a good one and something with which you should be concerned, given your goal of buying a home. To answer your question, I am going to illustrate with an example.

You entered into an agreement with your creditor to pay what you owe under certain guidelines and restrictions; namely, to pay a certain amount of money each month by the due date. Let's say you enter into an agreement with a friend to whom you loan $2,400.

The agreement states that the friend will pay you $200 a month for one year to pay off the loan. The friend pays on time the first three months, but the fourth month he says he can't make the payment and will catch up next month. The fifth month he pays you $100 and says he will make up the difference the next month. The sixth month he says he lost his job and he will not be able to pay the $1,700 he still owes.

You provided the money in good faith and trusted that the friend would uphold his end of the agreement. In this case we'll assume that you have enough money so that the loss of $1,700 is not the end of the world, just as your charge-off is not going to bankrupt your creditor. However, you would be leery and might be a little crazy to enter into a new financial agreement with this friend again if you expect to be paid.

Now let's say several years go by and the friend contacts you regarding the money he owes. He offers to pay $850 and says he hopes that you will accept that amount as final payment. You agree to the arrangement and he sends the check.

My question to you is, how would you feel about entering into a financial arrangement with this friend again? His attempt to make good on the loan by paying half of what was owed may affect how you feel, but more than likely you would avoid loaning him money again.

A potential creditor may look at your settled charge-off in much the same way. Unlike you, however, creditors are in the business to loan money. So while you may still qualify for a mortgage loan, it may be at a higher interest rate or with a larger down payment.

My advice is to suck it up and pay the entire amount of what is owed. One last thing to consider is that if the amount settled is significant, the lender will report the transaction to the IRS. A debt that is forgiven becomes income, on which you will owe taxes! So you could end up with a large unexpected tax bill right around the time you are getting into your new home!

As to your question about the mechanics of FICO scoring, many variables are considered in your FICO score, but generally speaking, if the account listing from your original creditor shows an unpaid balance for the charge-off, your score will improve if you pay the debt in full. A settled charge-off, in most cases, will not raise your score and might lower it, depending on the strength of the rest of your report.

Good luck!

The Debt Adviser, Steve Bucci, is the president of Consumer Credit Counseling Service of Southern New England. Visit CCCS for additional debt advice or click here to ask a debt question.

-- Posted: Jan. 28, 2005

Average mortgage rates and points in the top 10 markets



Mortgage Matters: A daily Weblog on mortgage rates


My First Home: A first time home buyer guide


Looking for more stories like this? We'll send them directly to you!
Bankrate.com's corrections policy

30 yr fixed mtg 3.80%
48 month new car loan 2.97%
1 yr CD 0.70%

Mortgage calculator
See your FICO Score Range -- Free
How much money can you save in your 401(k) plan?
Which is better -- a rebate or special dealer financing?

Begin with personal finance fundamentals:
Auto Loans
Credit Cards
Debt Consolidation
Home Equity
Student Loans

Ask the experts  
Frugal $ense contest  
Form Letters

- advertisement -
- advertisement -