How Bad Debt Affects Your Credit Score

Your credit score is an estimate, made available to lenders and other financial services companies, of the likelihood that you will pay off a new loan. The scores are developed by credit report agencies, which collect information on your financial history and enter it into a formula, calculating your creditworthiness. When you fail to pay back a loan according to its terms, this makes you appear less creditworthy and lowers your score.

Beginning Scores

According to the Fair Isaac Corporation, people with higher credit scores will actually see greater declines in their score if they incur bad debts as opposed to people whose credit scores are already relatively low. This is because incurring a bad debt is relatively consistent with the credit history of a person with a low credit score. However, a bad debt represents a major shift in the credit history of a person with good credit, requiring the credit reporting agency to make a more drastic correction.

Late Payments

According to the Fair Isaac Corporation, the company that pioneered the modern version of the credit score, a single payment that is late by 30 days can badly hurt your credit rating. Depending on the rest of your credit history and the size of the debt, this late payment can drop your score between 60 an 110 points.

Bankruptcy

One of the single most devastating effects on declaring bankruptcy is the damage to your credit score. When you declare bankruptcy, most of your debts are set aside and forgiven. This is the equivalent of having an enormous number of debts written off. According to the Fair Isaac Corporation, your score may fall by up to 240 points. Bankruptcies can only listed on a credit report for up to 10 years, but in most cases, your score can improve over that time with improved financial habits.

Debt Settlement

If your debt becomes unmanageable---meaning you cannot pay down the existing debt without suffering major personal or financial consequences---you may attempt to settle the debt. Under debt settlement, your creditors agree to accept less money than the person actually owes. The Fair Isaac Corporation states that a debt settlement can cost a person between 45 and 125 points, depending on the person's previous score and size of the debts settled.