Does Negotiating a Debt Settlement Lower Your Credit Score?

Individuals who are deeply in debt may consider signing up for a debt settlement program. These programs often promise to help people settle their outstanding debt obligations for pennies on the dollar. Those who are at risk of damaging their credit may feel that a debt settlement can help to repair their credit, but negotiating a debt settlement may have a negative effect on consumers' credit scores.

Debt Settlement

Debt negotiation participants generally sign up for their credit programs through a debt settlement agency. Many of these companies set up holding accounts that consumers deposit funds into monthly. The agencies then attempt to negotiate a lower payoff amount with the debtors and use the consumers' funds to pay off the outstanding obligations.

Beginning a Settlement

When individuals agree to begin a debt settlement program, agencies often encourage them to stop paying their current debts, since finance companies may not be willing to negotiate a lower balance on accounts in good standing. Once a consumer stops paying his debts, his accounts go to collections. Then the debt settlement agency begins attempting to work out a lower balance due with the finance company. While the negotiations are continuing, consumers begin depositing funds into the agency's holding account.

Impact on Credit Score

Since consumers must allow their credit accounts to go into default before they can begin many debt reduction programs, the process of negotiating a debt settlement can drastically lower credit scores. Often, financial companies that learn an individual has entered into a settlement program close the consumer's accounts and begin making collection calls immediately. This action alone is enough to damage a credit score. Consumers should be aware that the negative impact from a debt settlement can remain on their credit score for up to seven years.

Other Concerns

Another possible credit concern for debt settlement participants is the uncertainty as to whether a financial company will agree to a settlement. Some companies do not negotiate outstanding balances, meaning consumers will continue to owe the original balance due along with late fees and interest penalties. Since these same individuals will likely have their accounts frozen, they may remain in debt without access to additional credit, which can further damage their credit score.