You may be inundated daily by tempting advertisements offering to settle your credit card debt for a fraction of what you owe. While debt settlement is legal, you must be careful in choosing a service to handle your settlement. It's also important to understand the various ways settlement impacts your credit and your ability to borrow in the future.
Credit Card Settlement
Credit card settlement occurs when you pay a portion of your debt back rather than the full amount. According to SmartMoney writer Aleksandra Todorova, the amount paid typically ranges between 20 and 75 percent of your full debt. Settlement payments are made all at once. In general, the only reason creditors agree to settlement is if you are at risk of filing for bankruptcy -- they would prefer to receive a partial payment rather than no payment. However, to qualify for settlement, you must already show signs of bankruptcy risk, such as defaulted accounts.
Credit Report
Once your settlement is completed, you must regularly review your credit report to ensure that the account is reported as settled, and that you are not shown as delinquent. Oftentimes, a settled account is reported as "Debt settled for less than full amount due" or "Settled." If your creditor continues to report your account as delinquent, it could further impact your credit score. The settlement itself will negatively impact your score; however, the extent of the impact is dependent on what already exists on your report. If you have lots of accounts with delinquencies, your score won't drop much lower. Those with higher scores and good standing on other accounts may see a significant drop in their scores.
Obtaining New Credit
When new lenders see that you paid a settlement, they may take this as a signal that you have had financial troubles in the past. Since a settlement indicates that you didn't pay the full amount that you owed, lenders may be hesitant to lend you money. However, if you continue to build up your credit by paying bills on time and keeping balances on your remaining accounts low, you will find lenders willing to offer you loans with decent interest rates in the future.
Warnings
Part of the reason debt settlement has earned a poor reputation is because of debt settlement companies that charge unreasonable fees or operate scams in which they never actually turn the settlement money over to the creditors. The Federal Trade Commission recommends working with a credit counselor recommended by the National Foundation for Credit Counseling, whose website lists reputable counselors by location.
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