Impact of Debt Forgiveness on Credit

If you have delinquent credit card bills, medical bills or other unsecured debts, you may be able to negotiate a settlement with your creditors. Debt settlement allows you to pay less than what you owe and in return, creditors agree to forgive the remaining balance. While debt forgiveness can help you resolve your debts for less, it can also have a significant impact on your credit.

Negotiating Debt Forgiveness

There are two ways to negotiate debt forgiveness with your creditors. First, you can hire a debt settlement company to work with your creditors on your behalf. Typically, you would pay the debt settlement company a fee for its services. During the negotiation period, you would make a payment each month to the debt settlement company. During this period, your creditors will most likely continue to report your account as delinquent to the three credit reporting bureaus. If you choose to settle debts on your own, your accounts will also be reported as delinquent until you and your creditor can reach a payment agreement.

Debt Forgiveness Reporting

How your creditor reports the forgiven debt to the credit reporting bureaus can determine how quickly your credit will recover. As part of the debt negotiation process, you can also negotiate how the debt will be reported once the settlement is paid. You can request that the creditor report the debt as "paid in full" rather than "settled in full" to minimize the damage to your credit. Having the debt reported as paid in full does not erase the history of delinquency but it does demonstrate to potential lenders that you're attempting to repay what you owe.

Improving Your Credit

While the impact of debt forgiveness is not as significant as having a foreclosure or bankruptcy, it can take time for your credit to recover. Negative items can remain on your credit report for up to seven years. As your settled accounts age, the negative information contained in your credit file holds less weight in determining your credit score. If you are able to obtain a new credit card or line of credit, you can begin rebuilding your score by paying in full each month and always paying on time.

Considerations

Carefully research any debt settlement company prior to contracting its services. The Federal Trade Commission advises consumers to avoid any company that demands an upfront fee prior to giving you a personal consultation. The Internal Revenue Service may require you to pay federal income taxes on any amount of forgiven debt over $599 unless you can prove you were insolvent at the time the settlement occurred. If you plan to settle debts on your own, maintain a written record of all communications with your creditor. Never allow a debt collector direct access to your bank account.