The Impact of Debt Settlement

Taking advantage of a debt settlement arrangement offered to you by a creditor can impact you in both positive and negative ways. Although the stress level of owing a debt may be lessened, the settlement itself can have an adverse effect on your credit score. You can take action ahead of time to reduce the negative impact a debt settlement can have on your credit history by negotiating with your creditor.

The Facts

Debt settlement occurs when a creditor to whom you owe money accepts less than the amount you owe as payment for the debt. Debt settlement is not typically offered to you until you fall behind on payments and are in danger of defaulting on the debt. You can request a debt settlement offer from a creditor at any time prior to this, but the decision of whether or not to extend this privilege belongs to the creditor. Debt settlements are negotiated on a case-by-case basis.

Benefits

Paying a debt settlement offer has a positive impact on both you and your creditor. Not only are you allowed to pay much less for the debt than you would have without the settlement, but you gain peace of mind knowing that your debt is paid. You do not have to worry about legal action from your creditor to recover the debt. Even though creditors receive less than they are owed through debt settlements, the amount they receive is still greater than the amount they would have received from a collection agency. In addition, participating in a successful debt settlement prevents your creditor from being forced to report your debt as a tax loss.

Negative Effects

Settling a debt has a negative effect on your credit score, but you may be able to lessen the damage it does. Two factors contribute to how damaging a settlement may be to your credit score. The first is the payment history of the debt itself. Debts are rarely settled by creditors unless you have been late on payments and there is a chance you will default. Late payments hurt your score. The second way a settlement negatively impacts your credit score is by the debt being reported as "settled" on your report rather than "paid". You may be able to negotiate with your creditors to get rid of any late payments that are on file and to report your debt as "paid" rather than "settled". This will negate any negative effects the debt settlement has on your credit history.

Time Frame

Settled accounts will appear on your credit history for a seven-year period. The impact an account has on your credit score is determined primarily by your payment history on the account. Your payment information for the past two years is reflected on each debt in your credit file. If a debt is settled, it is technically considered a derogatory notation, but lack of late payments may have a positive impact on your score rather than a negative one. As the settled account ages, it has less of an impact on your score.

Warning

Opting for debt settlement does not make the unpaid balance of the debt disappear. Your creditor may still sell the unpaid balance to a collection agency. Collection agency reports have a devastating effect on your credit score. You must get a statement in writing from your creditor agreeing not to sell the unpaid balance of your debt after the settlement is complete. If your debt is sold to a collection agency, you will be responsible for added fees and may even be sued over a debt you already settled.