Debt Settlement That Doesn't Impact Credit

Since the Great Recession that began in 2007 took hold, America's citizens have been spending less, saving more and paying down debt. Unfortunately, certain borrowers may have so much debt that settlement may appear to be the only option. Although negotiating and settling debt is a perfectly legal process, how it affects your credit depends upon a variety of factors. If your credit score is your top consideration, it may not be the best route to debt freedom.

FICO

FICO, the Fair Isaac Corporation, collects lender and borrower data and reports it to credit bureaus. The three largest bureaus are Equifax, Experian and TransUnion. The credit bureaus issue a FICO score that predicts how risky you're considered to be as a borrower. Your payment history and how much you owe account for almost two-thirds of your score. As a result, late payments on high balances damage your credit before you've even begun to negotiate with your creditors. Before agreeing to a settlement, analyze your credit scores. If you have recent late payments, your credit is already significantly damaged --- settlement may not make much of a difference.

How Debt Settlement Works

It's unusual for a creditor to consider accepting a negotiated settlement unless you're so delinquent that the creditor suspects you might declare bankruptcy. To qualify for a settlement, you usually must be three to six months behind on your bills. As a result, because of the way the FICO score works, your credit score drops immediately. Even if you're able to negotiate a settlement with a creditor without going delinquent, your creditor probably won't agree to report your balance as "paid in full" to FICO. As a result, the chances of negotiating a debt settlement without damaging your credit are slim to none. Nevertheless, it can't hurt to try; reaching out to your lender's loan mitigation department is the best way to begin negotiations.

A Less Damaging Alternative to Debt Settlement

If you contact your lender and it's not willing to settle with you, there are alternatives to debt settlement. If you're not late on payments and don't wish to become so, your best choice is to contact a reputable nonprofit credit counselor. The counselor can negotiate with your lenders on your behalf, and she may be able to arrange smaller payments and reduced or eliminated interest. Your debts will be paid in full within three to five years. Although your participation in a debt management plan is noted on your credit report, it's not nearly as damaging as late payments or settlements.

Improving Your FICO Score After Settlement

Remembering that your credit score is only a snapshot in time is a comfort. Even after a bankruptcy --- the worst-case credit scenario --- it's possible to recover and increase your score. Late payments and settlements last on your credit report for seven years; however, the more time that passes since your last delinquency, the less effect it has on your credit history. Keeping all future payments timely and your balances low does more to improve your credit quickly than you might imagine.