What Does a Settlement Do to My Credit?

Debt settlement is considered a negative credit event and hurts your credit score, potentially making it difficult or impossible to receive credit at competitive rates for a while. Debt settlement allows you to resolve debts by paying less than the full amount owed, but the advantage is offset by damage to your credit score. A negative entry is added to your credit report for each settlement, noting that the account was "settled for less than the full amount owed." That's a red flag for future creditors who may consider you a poor credit risk.

Excessive Debt

Many people considering debt settlement are willing to accept short-term damage to their credit score. Everyone's situation is different, but it is possible that your credit score could drop by more than 100 points if you settle multiple debts. On the other hand, some people battling excessive debt already have poor credit scores because of high debt levels and missed payments. That means their actual credit score may not drop much because it is already low.

Risk

Credit scores range from 350 to 850, with a score of 620 representing the cutoff for good credit. Credit scores of 720 or higher are considered ideal and qualify you for the best rates on loans and credit cards. Settlement is clearly more damaging to people who may have spent years building a credit score in the 700s. The decline in score begins once you start missing payments. Creditors have no incentive to settle accounts that are paid on time and won't discuss settlement until you the account is about three months past due. Settlement information is reported on credit reports for seven years, but the impact on credit scores will lessen with the passage of time.

Pay-for-Delete

Some people try to minimize the effect on their credit by negotiating so-called "pay-for-delete" agreements. They agree to pay the delinquent debt in exchange for the entire account being deleted from credit reports. In this situation, no settlement information is added to the report. The credit bureaus rely on creditors to supply account information, and this gives creditors the power to remove information as well. Although "pay-for-delete" agreements do happen, they are not widespread, and creditors are not obligated to accept such an offer.

Alternative to Bankruptcy

The Federal Trade Commission recognizes debt settlement as an alternative to bankruptcy, and points out that settlement is less damaging to your credit. Bankruptcy is reported on credit reports for 10 years, and is considered the most negative credit event possible. Some people on the brink of bankruptcy because of excessive debt find that they can accomplish many of the same objectives through settlement. Settlement allows unsecured debts such as credit cards to be paid off for 20 percent to 70 percent of the balance, with settlements for about 50 percent of the balance common.