Although paying a creditor less than what you owe to settle a debt will lower your credit score, it’s preferable to ignoring unpaid debt. It’s worth exploring alternatives before seeking debt settlement.
Debt settlement can reduce financial burdens but damage your credit since it involves negotiating the forgiveness of a financial obligation in exchange for a partial repayment. And, if you hire a so-called debt-relief company to help, it will likely be expensive.
You should be aware that seeking debt settlement is risky, even if you can avoid paying expensive fees by going it alone. For starters, creditors may refuse to work with you (or any company you hire) to settle your debt. Also, reaching a debt settlement often involves racking up delinquent payments that damage credit scores. Additionally, settling an account rather than paying it in full is viewed negatively because it means the creditor accepted less than what was owed, incurring a loss.
The Impact of Debt Settlement on Your Credit Score
Debt settlement is a process of negotiating with creditors to pay back a portion of your outstanding debt in exchange for forgiveness of the remaining balance. While it can be a way to escape overwhelming debt it comes with a significant cost: a hit to your credit score.
Understanding the Impact
The precise effect of debt settlement on your credit score is contingent upon multiple factors, such as:
- The severity of your debt: The more debt you settle, the greater the negative impact on your credit score.
- Your credit history: If you have a good credit history, the impact of debt settlement will be less severe than if you have a poor credit history.
- The number of accounts settled: The more accounts you settle, the greater the negative impact on your credit score.
- The type of debt settled: Settling secured debt, such as a mortgage or car loan, can have a more significant impact on your credit score than settling unsecured debt, such as credit card debt.
Estimating the Point Drop
It’s challenging to estimate how many specific points debt settlement will deduct from your credit score. Industry insiders, however, calculate that the typical decline is between 50 and 100 points. In certain circumstances, the decline may be even more noticeable, particularly if you have a clean credit record or settle a substantial debt.
Factors Influencing the Point Drop
Several factors can influence the severity of the point drop, including:
- Credit utilization: Your credit utilization ratio is the percentage of your available credit that you’re using. Settling debt can lower your credit utilization ratio, which can have a positive impact on your credit score.
- Payment history: Your payment history is the most important factor in your credit score. If you have a history of making late payments, settling debt can further damage your payment history and lead to a more significant point drop.
- Credit mix: Your credit mix is the variety of credit accounts you have. Settling debt can reduce the variety of credit accounts you have, which can have a negative impact on your credit score.
Minimizing the Impact
While debt settlement will inevitably impact your credit score, there are steps you can take to minimize the damage:
- Settle only when necessary: Only consider debt settlement as a last resort if you’re unable to make your minimum payments.
- Settle with fewer creditors: The fewer creditors you settle with, the less damage it will do to your credit score.
- Pay off settled debts quickly: Once you’ve settled a debt, pay it off as quickly as possible to minimize the negative impact on your credit report.
- Build positive credit history: After settling debt, focus on building positive credit history by making on-time payments on all your other debts and keeping your credit utilization low.
Alternatives to Debt Settlement
Prior to using debt settlement, think about the following alternatives that might not have as much of an effect on your credit score:
- Debt consolidation: This involves taking out a new loan to pay off your existing debts, which can lower your interest rate and make your payments more manageable.
- Debt management plan: This involves working with a credit counseling agency to create a repayment plan for your debts.
- Negotiate with creditors: You may be able to negotiate with your creditors to lower your interest rate or monthly payments.
Although it can be a useful strategy for getting out of deep debt, debt settlement has a drawback: it lowers your credit score. You can anticipate a decrease of 50 to 100 points or more in your credit score, though the precise effect will vary based on a number of factors. In order to reduce the harm, think about settling with fewer creditors, paying off settled debts swiftly, and establishing a good credit history. Look into other options that might have less of an effect on your credit score before settling your debt.
Why Settling an Account Is Better Than Not Paying at All
Even if there may be a drawback, paying off a portion of your debt rather than ignoring it and not paying it off will improve your credit and peace of mind. The creditor will usually assign a debt to a collection department or outside collection agency if you fail to pay it.
Accounts in collections are typically listed on your credit report and will hurt your credit scores. Whats more, collection agents can be relentless in their use of phone calls and emails seeking payment. They can also file a lawsuit against you, and if they win, they can have a lien put on your property for the amount you owe, garnish your wages, or seize your bank accounts.
How Long Do Settled Accounts Remain on Your Credit Report?
As with most other negative credit report entries, settled accounts stay on your credit reports for seven years. The starting point for the seven-year countdown depends on the status of the account when it was settled:
- Late-paying accounts: If the account is settled, it will disappear from your credit report after seven years from the initial delinquency date or the first late-payment date that the account was never brought current.
- Accounts with no late payments: At the time of settlement, if the account is in good standing and shows no late payments, it will be removed from your credit report after seven years.
This might imply that it’s advantageous to purposefully miss payments prior to requesting account settlement in order to expedite the removal of a settlement entry from your credit reports, but keep in mind that:
- Your credit score is impacted by each late payment, but the first one on an otherwise clean credit history can have a particularly negative impact.
- Since some creditors won’t even consider debt settlement until you’ve missed one or more payments and because so-called credit repair companies usually advise you to stop making payments to your creditors, which results in delinquencies, settling an account in good standing may not be an option at all.
How will debt settlement affect your credit score?
FAQ
Will my credit score increase after settlement?
Do settled accounts improve credit score?
Will settling collections improve credit?
Is settled on your credit report bad?
How does a debt settlement affect your credit score?
High credit utilization depresses credit scores. Debt settlement eases that pressure. Legally settling a debt also blocks the creditor from suing to collect it—a clear plus. When a creditor contacts a borrower with a settlement offer, it may be a signal that the lender is moving toward seeking a legal remedy.
Does settling a debt with partial payment affect a credit score?
Different credit scoring models also treat debt settlement differently. But the effect of settling a debt with partial payment is usually negative, often significantly so. That’s because payment history is the biggest single factor in calculating a credit score, representing 35% of the result.
Will settling multiple credit cards hurt my credit score?
Your credit score could fall even further if you settle on multiple accounts. Debt settlement will hurt your credit score more if the credit cards you settle are already in good standing and if you end up settling multiple credit card accounts.
How long does a settled account stay on your credit report?
The settled accounts will also stay on your credit report, and an account’s payment history, age and other information can affect your credit scores until the account is removed. If the account was past due when it was closed, the entire account falls off your credit report seven years after the initial late payment that led to the closure.