How Debt Settlement Affects Your Credit Rating

Debt Settlement is often used by borrowers who are deep in debt and unable to repay. The lenders will settle your debt for a percentage of what is actually owed. This is a better choice than bankruptcy in regards to your credit, but there still are consequences to debt settlement.

What Debt Settlement Is

Debt settlement is a reduction of the amount of debt that must be repaid by the borrower. The amount varies by individual, but usually is 40 to 50 percent of the original debt. This can be achieved by negotiating directly with your creditors loss-mitigation department. They will work with you to create a plan that is affordable. Many borrowers hire a debt settlement company in hopes of getting a better reduction. The company then negotiates on your behalf with the creditors. The process can take months or even years.

Your Credit Score

Initially, your score will take a hit from the debt settlement. The creditors may mark your accounts as settled or not paid as agreed. In essence, you did not fulfill your obligation to the creditor. You owed a certain amount of money, and only paid a fraction of the debt. This shows on your report and will make future creditors hesitant to work with you. Some companies will take months to settle, in which case your payments will have been delinquent for those months. In addition, settled accounts will probably be closed by the creditor, and closing of credit lines causes a drop in your score. Length of credit history makes up 30 percent of your credit score. If the accounts that are settled and closed are old lines of credit, this could be a huge hit to your credit score. However, the initial drop in your credit score will not be as great as that of a bankruptcy.

After the Debt Settlement

Months to years after the debt settlement, your credit score may actually rise. You will no longer have the delinquent payments on your report. You also will have a much lower debt-to-income ratio after all of the debt is cleared. Credit card balances and timely payments account for about 60 percent of your credit score. The settled accounts will remain with you for seven years to come, but during those seven years you should do everything you can to improve your score. Maintain old lines of credit if you can. These will be important, and you probably won't be able to open any new accounts for a while. Be sure to make timely payments on the lines of credit that were not part of the settlement. Debt settlement is harmful to your credit rating, but it allows you to start over and repair your credit for the future.



Does timely payment of debt settlement improve your credit?



Making debt settlement payments on time is definitely better than paying them late. The process of debt settlement is going to severely hurt your credit in most cases. With debt settlement, you are still paying less than you actually owed to one of your creditors. Even if you make your payments on time, your credit will still be damaged. With that being said, if you agree to a debt settlement and then you do not make the payments as agreed, it can hurt your credit even further. It is best to avoid additional damage.

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