A debt settlement takes place when a creditor agrees to accept less than what you owe. The remaining balance is written off, or forgiven. You can negotiate a settlement yourself or through a debt-settlement company. Regardless off the method you choose, you need to be aware of the effect that a settlement can have on your credit report.
Settling Through a Debt-Settlement Service
Debt-settlement companies often solicit business from individuals who have credit card debt. They attract customers with promises to cut down debt in half. However, new customers often don't know how the program works until it's tool late. If you choose to settle through a debt-settlement company, the impact on your credit report will depend on your credit history.
If you're current on your payments, using a debt-settlement service can damage your credit. The way the program works is that you send a monthly payment to the agency. The payment normally includes a service fee. Your payment, minus the service fee, is placed in an account. Once you have enough money in your account to make a settlement offer, the agency contacts the creditor and negotiates a settlement. All the while, your creditor does not receive any payments until a settlement is reached, which means that you now have a negative payment history on your credit report.
Self-Negotiations
Once you you're behind on your payments anywhere from 3 to 6 months, credit card companies will often attempt to negotiate a settlement. The negative effect on your credit report will not be as significant if you can reach a settlement before the account is placed with a collection agency. If you had a good payment history prior to falling behind, the creditor may agree to report your debt as paid in full or paid as agreed to the credit bureaus. Otherwise, your credit report will show your debt as settled and the written off amount will also appear. Although this is better than leaving the debt unpaid, it could have an unfavorable effect in your ability to obtain credit in the near future.
The Aftereffects of Debt Settlements
Settling a debt will inevitably have a negative effect on your credit report. However, by the time a debt is settled, the some damage has already been made. Fortunately, your creditworthiness consists of two components, your credit score and your debt-income ratio. Although your credit score will plummet with a settlement, your debt-income ratio will increase as soon as you settle a debt. You should see your credit improve significantly within the next two years. Debt settlements normally fall off your credit report after 7 years.
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