Often, people will attempt to settle a debt for less than they actually owe on it. The main advantage to this is that the person will have to spend less money paying back the debt. In addition, if this pulls the debt out of delinquency, the person may get to stop paying late fees and be able to begin to repair any damaged credit. However, debt settlements can damage a person's credit rating, too.
Debt Settlement
According to the New York Times, many credit card companies are willing to settle debts with clients for less than the people actually owe. This is because the cost of collecting the debt can often outstrip the amount of money that the company is likely to receive for the debt. Also, customers who are deeply in debt may be on the verge of bankruptcy, in which personal debts are often dismissed, giving the companies a motive to take what they can get now.
Credit Reports
When a person takes out a credit card, the issuing company will notify a credit reporting bureau of the new line of credit. The credit reporting bureau will keep a record of this debt in the person's credit report. As the person pays off the debt, the credit reporting bureau will change the status of the person's report to reflect these changes. This report is the only information used to form a person's credit score.
Credit Scores
Credit reporting bureaus base credit scores on what the information in the consumer's credit report indicates about her creditworthiness. Individuals who pay back loans on time and pay the total amount that they owe receive higher ratings than people who pay back debts late or only in part. Therefore, people who settle debts will see a drop in their credit scores, as bureaus rate people who pay only pay of a debt as less creditworthy.
Reporting Settlements
According to Lita Epstein, author of "The Complete Idiot's Guide to Improving Your Credit Score," technically, a creditor does not have to report a debt that is settled as a settlement to a credit reporting company. Rather, the creditor can choose to report the debt in a way that will not hurt the person's score as much. For example, the creditor could report the debt as having been paid in full. The debtor could, in fact, make reporting the debt in this way a point of negotiations to settle the debt.
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