A debt settlement is a process by which a creditor agrees to accept less than the amount owed to settle the debt in full. For example, if a consumer has a $10,000 bill but can't pay it, the creditor may accept a lump sum payment of $5,000 to completely settle the account. While settling a debt can help a consumer to remove a financial hardship, the settlement will hurt the consumer's credit score.
Impact on Credit
Though debt settlement will certainly have a negative impact on a consumer's credit score, the exact amount of the impact will vary depending upon a number of factors. While it isn't possible to state how much lower a credit score will be due to a debt settlement, those with higher credit scores will suffer the largest reduction. The reason for this is that consumers who have a low credit scores will typically already have negative information on their credit report.
Considerations
Most consumers seeking to settle debt are already behind on the payments. In fact, most creditors will not consider settling unless the consumer is already behind. While settling a debt will result in a negative impact on a credit score, doing nothing and allowing the debt to get further behind will also provide negative information to the reporting agencies. With a settled debt, the account stops showing an open, past-due amount month after month. However, the creditor reports that the consumer paid less than the full amount to settle the account, which hurts the credit score. If a consumer is going to negotiate a settlement with a creditor, the consumer should consider negotiating the deal himself. There are debt settlement companies that provide this service, but they often charge large fees.
Alternatives
Consumers should consider entering a debt management plan with a credit counseling agency. A credit counseling agency may be able to negotiate a lower interest rate and reduced payment amount with the creditor. Credit counseling agencies often charge fees for their services. While credit counseling may reduce a credit score, the impact of credit counseling will be less than the impact of debt settlement. Another alternative for consumers to consider is bankruptcy. However, bankruptcy will have similar or worse effects on a credit score than debt settlement.
After a Settlement
After a consumer completes a debt settlement, the consumer should request a copy of her credit score. The consumer should make certain the creditor properly reports the settlement to the credit reporting agency. Consumers should diligently pay all debts on time after the settlement to begin rebuilding a good credit history. A consumer can open a secured credit card that reports card activity to the credit reporting agencies as a way to increase the amount of positive information received by the credit reporting agencies.
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