Debt settlement involves using an outside agency to negotiate with lenders to reduce the total amount owed. Credit bureaus use the Fair Isaac Corporation (FICO) model to score consumer credit information for potential lenders. Debt settlement will affect your credit score, but just how much depends on your starting score and overall lending history. Most negative information remains on your score for up to seven years.
Debt Settlement Process
With debt settlement, you make payments to a settlement agency over time, amassing enough money in an account to make a reasonable offer on your debts. Debt settlement companies generally wait until your accounts become delinquent to negotiate with creditors. The reasons for waiting are twofold; the longer your accounts are delinquent the more likely a creditor is to accept an offer and waiting allows funds from your payments to increase enough to make an offer. The debt settlement agency then negotiates with creditors to settle for a reduced payment on the total amount due.
Credit Scoring
Debt settlement will negatively influence your credit score in two ways. First, when you stop paying lenders to as you try to negotiate with them, late payments end up on your credit report, lowering your score. Second, your report will show that the account was settled for less than the amount owed. A settled account is scored much the same way as a "charge-off" or a loan discharged in bankruptcy Barry Paperno, consumer operations manager at FICO tells Bankrate.com. The extent of the damage depends on your starting score and overall credit history. Generally, individuals with high beginning scores are hit the hardest.
Other Concerns
Debt settlement companies expect a fee and creditors continue to tack on penalty or late fees, increasing your total debt. There is no guarantee that a creditor will settle or even negotiate. Depending on state laws and the type of debt, lenders may initiate lawsuits leading to wage garnishment, bank levies or property liens. Depending on your total debt, settlement could take years to resolve. Additionally, the IRS may consider money you saved by settling the debt taxable income.
Considerations
The Federal Trade Commission cautions consumers against debt settlement companies asking for upfront fees, claiming "government bailouts," instructing you to stop communicating with creditors or guaranteeing results. Check with your state attorney general's office or the Better Business Bureau regarding a particular company's consumer history before committing to a debt plan.
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