Will Debt Negotiation Affect a FICO Score?

Debt negotiation is the same as debt settlement and has a profound affect on a FICO score. Debt negotiation allows you to resolve a debt for less than the full balance, but the process hurts credit significantly. FICO is a computer model for determining credit scores -- three-digit numbers ranging from 350 to 850. The higher the number the better, with scores of 720 or greater leading to the most favorable interest rates on credit cards and other loans. People in debt negotiation likely will find it impossible to maintain a high FICO score while paying off debts.

Process

Debt negotiation is possible only after a credit card or other unsecured debt is seriously past due -- usually by three months or longer. At that point the creditor may agree to negotiate a settlement ending the debt. According to SmartMoney.com, credit card companies sometimes agree to settle delinquent credit card accounts for 20 to 75 percent of the balance.

Reporting

Card companies and other creditors report account status information to the major credit bureaus each month. That means they notify the credit reporting agencies each time the debtor misses a payment. The FICO scoring model treats missed payments seriously, with a drop in score possible each month the debtor fails to make a payment on time. That's one reason why debt negotiation hurts scores. A credit card company or other unsecured creditor simply will not negotiate a current debt. There's no advantage for the creditor to do so. People calling debtors to negotiate a current debt are usually told they're not eligible for a settlement or negotiation.

Outcomes

A debtor's FICO score may have dropped significantly before the creditor is willing to negotiate. Some debtors negotiate settlements when accounts are past due for six months or even longer. By that time it is likely that the debtor's credit score has fallen below 620 -- the cutoff for so-called "good" credit.

Considerations

A drop in credit score isn't an issue for some people in debt negotiation. That's because they may already have bad credit when they decide to negotiate payoffs. People who have a high FICO score have much more to lose in debt negotiation. A person with a 700 FICO score who decides to negotiate one or more debts could theoretically lose more than 100 points off the FICO score before the process is complete. However, someone starting debt settlement with a 500 credit score may experience little drop in score because the score is already poor.