How Does Debt Settlement Affect Your Credit Score?

What Is Debt Settlement?

Debt settlement is a process in which a debt settlement company negotiates a reduced payment to a credit card company on behalf of a debtor. It is a method used by people who have gone so far into debt that they are struggling with paying off what they owe their creditor.

How Debt Settlement Works

When you hire a debt settlement company to negotiate a reduction of your debt to a creditor, generally the debt settlement company collects an upfront fee from you to secure its services and then a regular payment from you for an agreed upon period of time, often three to six months. After you finish paying the company, it contacts your credit card company to negotiate an arrangement in which the credit card company is paid the amount the debt settlement company has collected from you. This amount is usually about 30 percent to 50 percent of the amount you owe to the credit card company. If the credit card company agrees, then the debt settlement company pays your creditor the amount it has collected from you and you no longer owe the credit card company the full amount of the debt.

Effects of Debt Settlement on Your Credit Score

Though there can be several negative consequences for a debtor who goes through debt settlement, the consequence that often does the most damage is the effect debt settlement has on a debtor's credit score. There are primarily two reasons for this.

First of all, when a debtor goes through debt settlement, he doesn't end up fulfilling the agreement he made with the credit card company. As a result, though the debt will be marked as "paid" on his credit score, it will not be marked as "paid-as-agreed." This can adversely impact one's ability to receive credit from other companies.

Secondly, during the time a debtor is going through the debt settlement process and is paying a monthly fee to the debt settlement company, the credit card company is not being paid. This will significantly affect a debtor's credit score.

As a result of these two issues, though the debtor would no longer have the debt to pay, it will be difficult for the debtor to receive credit from other companies while this information is on his credit record.