Prior to taking out a loan, credit card or line of credit, you and your lender reach agreement on the terms of the debt. Your lender agrees to provide you with credit, and you agree to repay the money on a monthly basis for a certain period of time. When you arrange a debt settlement, you deviate from the terms of your original credit agreement; this negatively impacts your credit score.
Settlement
You may find yourself struggling to repay your debts if variable interest rates suddenly rise, as this can cause your payment to increase. You may also have trouble repaying your debt if you lose your job or lose another source of income. Some people fall behind on debts because they take on more debt than they can reasonably afford to begin with. The fact that you cannot afford to pay the debt does not mean you are relieved of your responsibility to repay the money. However, your lender may agree to a debt settlement, which involves the lender allowing you to payoff the debt for less than the balance owed. Lenders only agree to settlements if such a deal seems to represent the lender's best chance of recouping some of its money.
Default
If you make your monthly debt payments on time, then your lender has no incentive to enter into a debt settlement arrangement. You can only enter into such a deal if you have fallen behind on your debts. Depending on your state's laws, you fall into default when you go between 30 and 90 days without making a loan payment. Your lender notifies the credit agencies about your missed loan payments and every missed payment has a negative impact on your credit score. Late payments stay on your credit report for seven years.
Settlement
You can agree a debt settlement directly with your lender or negotiate one with the aid of a debt settlement firm. The lender promises to stop pursuing you for the balance of the delinquent debt in return for your promising to make a one-time payment towards the debt. The lender reports the account as closed to the credit bureaus; but, crucially, the credit bureaus record the account as settled as opposed to paid. The payoff amount and the balance owed both appear on your credit report so other lenders can see that you failed to repay the debt in full. Settled accounts remain on your report for seven years and cause severe damage to your credit score.
Considerations
When you enter into a debt settlement, you no longer have to contend with one of your debt payments. This can both free up some of your cash and provide you with some peace of mind. Settling one debt may make it easier for you to manage your other credit accounts, and a positive payment history on your other debts will enable you to slowly improve your credit score. However, you may have to wait several years before other creditors will allow you to borrow money, and this could make it hard for you to buy a car or a home. Furthermore, if you arrange a settlement through a third party, you may have to pay hefty fees, and those funds could have been used to reduce your debt.
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