How Does Debt Settlement Affect Your Credit Score?

by Rebecca Lake

If you've got unpaid credit card charges, medical bills or other unsecured debts, your creditors might be willing to negotiate a settlement. When your creditor agrees to a settlement, you pay a percentage of what's owed and the rest of the balance is forgiven. Settling old accounts can help you save money and get out of debt faster without resorting to bankruptcy. There is a downside, however, in terms of how it affects your credit.

Negative Account Information

Generally, the extent to which a debt settlement harms your credit depends on the type of information that's already on your credit report. Having multiple late payments, collection accounts or charge-offs on your credit report can cause your score to drop as much as 200 points. If your credit score is already low, negotiating a debt settlement might not have a significant impact. If, however, your accounts are current or you're past due by less than 30 days, the negative impact of a debt settlement on your credit is likely to be much more noticeable.

Reporting Debt Settlement

As long as your account is being reported as "unpaid," your credit score will continue to suffer. When negotiating a debt settlement, you also need to negotiate how the account will be reported to the credit bureaus once it's paid off. Your creditor could report the account as "settled," "paid," "paid in full" or "paid as agreed." Having the account listed as "paid" rather than "settled" is generally less damaging to your credit. Your creditors are not required to report your account as "paid," but it doesn't hurt to ask if they'll consider it when you're offering a settlement.

Removing Negative Information

Negative information, including settled debts, can stay on your credit file for seven years, according to the Fair Credit Reporting Act. If you settle a debt, it's a good idea to check your credit report regularly to make sure the account is being reported properly. Once the seven-year mark passes, you might need to contact the creditor in writing to have the negative information removed if it doesn't fall off your report automatically.

Improving Your Credit

Your credit score is determined by your payment history, the amount of debt you owe, how often you apply for new credit, the types of credit you have and the age of your accounts. If your credit score has dropped following a debt settlement, you can help to increase it by making sure you pay your bills on time. This accounts for 35 percent of your credit score overall. Another 30 percent is based on how much you owe compared to your credit limit on your various accounts, so paying down your existing debts can also raise your score. You might also want to avoid applying for new loans or lines of credit immediately after a settlement, because multiple inquiries can cause your score to drop.

About the Author

Rebecca Lake is a freelance writer and virtual assistant living in the southeast. She has been writing professionally since 2009 for various websites. Lake received her master's degree in criminal justice from Charleston Southern University.

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