What Does Debt Settlement Do to Your Credit?

Settling a debt could be one of the fastest ways available to eliminate a debt without bankruptcy. While this method is effective, it can also drop your credit score. Once you settle a debt, you will suddenly become less attractive to lenders of all kinds. Before settling a debt on your own or with the help of a company, you need to think about the potential damage you are doing.

Why Debt Settlement Hurts Credit

The process of debt settlement involves giving a creditor a lump sum amount in exchange for closing out your account. When you settle an account, you can often do so for 50 percent or less of what you owe. This can save you a substantial amount of money, but you are not technically living up to your end of the bargain. When you entered into the debt, you essentially told the creditor that you planned on repaying it in the future. When you do not repay the entire debt, the creditor reports this as a negative on your credit report.

Credit Score Damage

The exact amount your score will drop after a debt settlement will depend on what it was before the settlement. Higher credit scores are more negatively affected than lower scores. At the low end of the scale, you might expect your score to be lowered by 45 to 65 points, according to MSN. If you had a higher score to begin with, it could drop by 105 to 120 points.

Negative Statements

Besides the damage to your credit score, settling a credit account can also put negative statements on your credit report. When creditors look at your credit report, they can see the status of each account that you have had for the last few years. When you settle a debt, the creditor may have reported it as "settled" on your report. This will remain on your credit report for the next seven years after it is originally placed on your report.

Debt Settlement Companies

Instead of settling the debt on your own, you may be interested in using a debt settlement company to help you. When you use a debt settlement company, you will usually pay a fee of the total amount that is settled. One of the advantages of using a debt settlement company is that they can sometimes get creditors to report your accounts as "paid in full." If this happens, you could salvage your credit after the settlement takes place.