Will Settling a Debt Affect My Credit Score?

Does Debt Settlement Hurt Your Credit?

While debt settlement may be an option for easing your financial burdens, it will harm your credit. Settlement can hurt your credit in a couple key ways.

First, there are the missing payments that lead up to settlement. So-called credit repair companies typically instruct you to stop making payments to your creditors, which leads to delinquencies. In some cases, settling an account in good standing may not even be an option: Some creditors won't even consider debt settlement until you've missed one or more payments.

Each delinquent payment does damage to your credit score, and the first late payment on an otherwise unblemished credit history can be especially damaging. Beyond late payments, a settlement is a negative event on your credit history that can make it more difficult to borrow in the future.

Be aware: Apart from the impacts on your credit, settlement can be expensive—especially if you hire a so-called debt relief company to help you. And, even if you avoid high fees by negotiating your debts on your own, you should be aware that seeking debt settlement is risky.

How Long Does Settlement Stay 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:

• Accounts with late payments: The settled account will expire from your credit report seven years from the original delinquency date, or the first late payment date after which the account was never brought current.
• Accounts with no late payments: If the account is in good standing (reflecting no late payments) at the time of settlement, it will expire from your credit report seven years from the settlement date.

Learn more: How Long Do Settled Accounts Stay on a Credit Report?

Why Settling an Account Is Better Than Not Paying at All

If you're considering settlement, your account may already be past due. Despite the potential downside, settling a debt by making partial repayment is better for your credit (and peace of mind) than neglecting it and leaving it unpaid. If you ignore a debt, the creditor will typically turn it over to a collection department or third-party collection agency.

Accounts in collections are typically listed on your credit report and will hurt your credit scores. What's more, collection agents can be relentless in their use of phone calls and emails seeking payment. They can also sue you and (if successful) garnish your wages, seize your bank accounts or have a lien placed against your property for the amount you owe.

Learn more: How to Get Out of Debt on a Low Income

How to Avoid Debt Settlement

If you feel unable to repay a debt in full, there are several options you may be able to pursue. Here are some alternatives to debt settlement:

Debt Consolidation

If your credit is good, debt consolidation can bring relief from high-interest debt. Using proceeds of a personal loan or home equity loan with a relatively low interest rate to pay off multiple high-interest card accounts can bring significant savings in interest charges.

Replacing multiple credit card bills, with minimum payment requirements that change each month, with a single, predictable fixed payment also can make budgeting easier.

Be aware: Consolidation is sometimes risky because it may free up your credit cards. That can put you at risk of running up new balances and going deeper in debt. So, be sure you only consider consolidation if you have a strong plan for avoiding this pitfall.

Debt Management Plan

A debt management plan (DMP) is a repayment plan arranged by a nonprofit credit counseling agency. Under this arrangement, the agency reviews your finances, helps devise a payment plan you can afford and then works with creditors to arrange for repayment over time. You make one monthly payment to the credit counseling agency, and they distribute payments to your creditors.

The agency often charges a modest upfront fee and collects additional fees from your payments, but costs typically are less than you'd pay a for-profit debt relief company. Note that credit card issuers may require you to close the accounts that are part of your DMP, limiting your access to credit and potentially hurting your credit scores.

Tip: The National Foundation for Credit Counseling and the Financial Counseling Association of America provide lists of reputable, certified nonprofit credit counselors who can help you set up a DMP.

Learn more: Is a Debt Management Plan Right for You?

Forbearance

If a temporary financial hardship is making it hard to pay your debt, lenders may be willing to extend forbearance. This is a short-term reduction or suspension of your monthly payments and/or a waiver on interest charges and fees.

Lenders typically only grant this option if asked and limit it to borrowers with good credit who can show that they'll be able to resume regular payments within six to 12 months. This option will extend the amount of time it takes to repay your debt, however.

Learn more: Does Forbearance Affect Credit?

Loan Modification

In a loan modification (also called a workout agreement when applied to credit cards), the lender permanently restructures your borrowing terms.The goal of a loan modification is to make your monthly payments more affordable.

Keep in mind, though, that loan modification can also have some unappealing consequences. For example, credit card issuers may reduce your borrowing limit. Issuers of installment loans may extend your borrowing term, which adds extra payments over the life of the loan and increases your total interest costs.

Learn more: How to Manage Your Debt

How to Improve Your Credit Score

Whether you're pursuing debt settlement, trying to avoid it or working to recover from its impact on your credit scores, taking steps to improve your credit is important for your long-term financial security. Here are some tips for building your credit scores:

• Make all payments on time going forward. Payment history—the record of your monthly debt payments, and whether they are made on time or delinquent by 30 days or more—is the most important influence on your credit scores. There's no habit that's better for your credit than paying debts on time every month, without fail.
• Pay down revolving account balances. The second most significant influence on credit scores, and the one scores respond to most quickly, is the amounts owed on your accounts. This factor includes credit utilization rate, which measures the percentage of the credit limit you're using on revolving credit accounts such as credit cards. If you have high balances on one or more revolving accounts, paying them down will improve your utilization rate and your credit scores will tend to follow suit.
• Address relevant risk factors. You can get your credit report and FICO^® Score^Θ for free from Experian, then review the risk factors provided with your score. These factors explain the top reasons your credit score isn't higher (and sometimes also tell you the circumstances helping your score the most). They can help you see what you can do to improve your credit scores.
• Try Experian Boost^®ø. Experian Boost is a free feature that lets you add eligible, on-time monthly bills to your Experian credit history, which can help your FICO^® Score based on Experian data. Eligible bills may include rent, monthly insurance premiums, streaming subscriptions, phone bills and utilities.

Learn more: How to Rebuild Your Credit

The Bottom Line

Debt settlement is risky and harmful to your credit. Before pursuing it, make sure you understand the potential consequences. Consider meeting with a certified financial counselor or an attorney familiar with debt negotiations to review all your options. If you pursue debt settlement, check your credit report throughout the process to be sure the status of each account is reported accurately.