A debt settlement will definitely affect your credit report, and not for the better. In a settlement, you and your creditor -- your hospital, your credit card company, possibly even your mortgage lender -- strike a deal where you pay some of what you owe in return for wiping out the remaining debt. You can save money and get out of debt but unpaid debts are never good for your credit.
Procedure
Most creditors won't listen to a debt-settlement request until after there's a problem -- for example, you're missing payment deadlines regularly or a couple of months delinquent. Contact your creditors, show them you can't pay off the full debt because of circumstances beyond your control, then offer a partial settlement. It's up to each creditor whether to accept your offer, go to court to get a debt judgment against you or risk that you file bankruptcy and he gets nothing.
Effects
Your payment history counts for 35 percent of your credit score, the largest single category in the FICO credit-scoring system. If your history includes an unpaid debt, it's a black mark on your report, even if your lender signed off on it. In some cases, it can hurt you as much as bankruptcy or repossession. Because you can't settle the debt until it's delinquent, that means you'll have several months of late or absent payments which will add further negatives on your credit report.
Mortgages
If you're delinquent on your mortgage, there are two housing-specific forms of debt settlement, the short sale and the deed in lieu of foreclosure. In a short sale, you find someone willing to buy your house and ask the mortgage lender to accept the sale price as settlement on the mortgage. A deed in lieu of foreclosure means the lender settles the debt in return for the deed. These may work better for you than foreclosure, but the effect on your FICO score is identical.
Options
If it's at all possible to pay off your debts, however difficult, you'll be better off doing so. You might benefit in getting advice from a professional credit counselor; you can find qualified ones through the National Foundation for Credit Counseling. If you have to negotiate a settlement, be careful of any company offering to do it for you: Debt negotiation is rife with scam artists who will charge a fat fee without getting you a better settlement.
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