A reader, Mr W, asked:
I had credit cards and got myself in a mess when getting balance transfers but keeping the old cards. Then I lost my job last year, but I am now working again. I have defaults ranging from 2015 to last month. All my debts add up to about £6,500.
Many of them have offered me a discount if I clear the outstanding balance. I have been offered a 20% discount on a £3,500 debt, is this a good deal? I might be able to borrow the money from a family member to pay them.
Will I be better off paying in full or accepting a discount? I would like to finance a car next year for £10,000.
Some facts about credit scores and partial settlements
Some general points first, then I’ll look at how they can affect Mr W’s decision about what to do.
Some of these may surprise you, so I have included links if you want a more detailed explanation.
- you are very unlikely to be offered a low settlement on a recent default. See “Is it too soon for low settlement offers to be accepted?”
- paying off defaults doesn’t improve your credit score at all. But it will make some lenders more likely to lend to you.
- settling a debt partially, not repaying full, adds a marker to the credit record for that debt. Other lenders can see this when you apply for more credit, but it doesn’t affect your credit score, that will be the same whether you settle the debt in full or partially… or not at all!
- some lenders may care about debts settled partially, others don’t mind just so long as the debt has been repaid.
So, will partial or full settlements help Mr W get this car finance?
With very recent defaults on his credit record, Mr W has no chance of car finance at a half reasonable rate in the near future. Whether the debts are settled in full or partially.
Look at it from the car finance lenders point of view – Mr W got into major problems before and he now wants to borrow a lot more money. Only bad credit lenders would be likely to consider him, at a very high APR.
If he waits a while – a year or more – after settling all the defaults and doesn’t have any more credit record problems during this time, then he may be able to get finance at an OK rate, but it probably still won’t be cheap.
Don’t borrow money to take a 20% off settlement offer
Mr W has been offered 20% off a £3500 debt by a debt collector. This would clear half his debt and it could be a good idea if he had the money in the bank. As none of the defaults are old, he probably won’t get a much lower offer.
But borrowing money to take this offer is a big mistake.
The interest on his defaulted debt is already frozen. If he borrowed the money commercially, paying interest, he wouldn’t gain anything at all from this. His credit score won’t improve and he now paying interest which could go wrong in the future.
Sometimes people want a consolidation loan to clear current and defaulted debt. This is normally at a high rate of interest and can be unaffordable in practice, even though it can sound like a neat solution in theory. Never consolidate debt except at a low interest rate, and never consolidate debt where you aren’t paying interest!
Mr W is hoping to borrow the money from family so he probably wouldn’t be charged interest. But often family loans come with emotional pressure. If Mr W was to lose his current job, he could drop his payments to the debt collector to a token £1 a month. But when he has borrowed from family, that could leave them in difficulty. Or the family lender could have financial problems themselves and need the money back.
Of course all this would be different if he was being offered 80% off not 20% off. That would be an offer worth stretching to take. Mr W could feel more confident he could quickly repay the much lower amount to a family member.
A better way forward
If Mr W has a relative that can lend him £3-4k and he has to have a new car, he has a much better option. Use the family loan to buy a cheaper car outright, no finance at all.
Then Mr W can use the £250+ a month the car finance would have cost – which he thinks he can afford – to repay his relative and set up payment plans for the defaulted debts.
This is a much lower cost and lower risk strategy. If his income drops, he can reduce the payments to the defaulted debts and not have the car repossessed.