Does Paying a Settled Amount Hurt Your Credit Score?

Debt settlement is perfect for resolving debt. The strategy allows a debtor to pay off credit cards and other unsecured accounts for a fraction of the original balance. The savings are sometimes tremendous, with SmartMoney reporting that some creditors will accept 20 to 70 percent of the balance to pay off an account. That means a debtor settling $30,000 in credit card debt could pay it all off for as little as $6,000 -- a savings of $24,000. However, there are drawbacks. Debt settlement for less than the full balance causes severe harm to credit scores during the settlement process and when you pay the settlement amount.

Process

People seeking to settle a debt must miss several payments to qualify, and that's where the credit problems begin. Banks and credit card companies will not settle accounts in good standing because they have no reason to do so. That means a person embarking on a debt settlement strategy will suffer harm to credit scores each month as the lender reports delinquent payments to the major credit bureaus.

Effects

Creditors generally are willing to discuss settlement payoffs after an account falls three to six months behind. By that time, a debtor who previously had good credit may have noticed a severe falloff in credit scores. Credit scores range from 350 to 850, with scores of 720 or higher seen as excellent. It is impossible for someone to maintain high credit scores while engaging in debt settlement. Also, once credit scores fall significantly, it can take two to three years to rebuild to former levels.

Negotiations

Settlement is a voluntary transaction between the creditor and the debtor. There is no guarantee that a creditor will agree to a settlement, making it possible that a debtor could miss several payments preparing for a settlement and have only damaged credit to show for it if the creditor refuses to cooperate. However, creditors are usually willing to negotiate settlements when they are certain that the debtor no longer is able or willing to pay the account as agreed. Some creditors contact debtors to make settlement offers, although the debtor is free to make the first move.

Credit Reports

Paying the settlement amount is the final part of the process. After receiving payment, the creditor will update the debtor's credit reports to show that the account was "settled for less than the full balance." That, too, hurts credit.