Does a Settlement Negatively Impact Credit?

A debt settlement does negatively impact credit, but how much is dictated by the situation. It depends on the debtor's credit score before settlement and other factors, such as balances and payments on other accounts. A person with great credit could experience a large drop in credit score after a settlement, while people with poor credit may experience little to no change because their credit score is already near the bottom of the scale.

Identification

Debt settlement allows debtors to pay off credit cards and other unsecured debts -- usually for less than the full balance. Settlements for 20 to 70 percent of balances are possible, according to "Smart Money" magazine. However, the process is not quick, and a debtor could experience drops in credit score each month for several months. Credit scores range from 350 to 850 with scores of 720 or higher considered excellent. Scores below 620 are poor, and debt settlement can cause a person's score to fall below that level.

Timeline

Creditors have no incentive to settle accounts that are current. A debtor seeking to pay off a debt through settlement must miss several payments before the creditor will consider it. The MSN Money website reports that credit card companies will consider debt settlement after accounts are three or four months behind. At six months, card companies usually close accounts and list them internally as charged off. Even then settlement is possible, but a string of missed payments and a possible charge-off can severely hurt credit even before the settlement.

Considerations

Major credit bureaus, such as Experian, update credit reports after receiving information from creditors. They update the debtor's credit report to show debts as "settled" or "settled for less than the full balance." Experian reports that settlement notations are very bad for a person's credit, and can cause scores to drop even more, in addition to the harm caused by missed payments.

Decisions

Debtors should not consider debt settlement just because they don't want to pay their bills. The overall damage to credit is usually too big a price to pay for that. Negative credit information -- such as missed payments, charge-offs, collection accounts and settlements -- remain on credit reports for seven years. People who engage in debt settlement may suffer from poor credit scores for two or three years as they attempt to rebuild. However, debtors facing bankruptcy may consider settlement a better alternative. Bankruptcy remains on credit reports for 10 years and is the worst credit event possible.

Rebuilding

Rebuilding credit after settlement requires paying all remaining bills on time while keeping balances low on revolving accounts, such as credit cards. Some debtors open new, secured credit card accounts to help the process. They make small charges on the card each month but pay them off in full at the end of the month. Secured cards require money in a bank account that serves as collateral. People with poor credit because of debt settlement and other reasons favor the cards, because they find it difficult to qualify for standard credit.