How Badly Will Debt Settlement Affect My Credit?

Debt settlement is an awful item on any credit report, but it is usually not as damaging as the events leading up to the settlement. Since any negative item has an unknown effect on a credit score, it is best to avoid settlement if possible. Settlement is usually the least optimal choice to tackle debt, and most customers do not benefit from or need debt settlement.

Considerations

How much a debt settlement affects a credit history depends on when the lenders agree to settle. Most creditors do not settle until the borrower misses several late payments. If the creditor writes off the account and sells it to a collection agency, the fact that the borrower refused or could not pay the debt does the brunt of the damage, according to Maxine Sweet of Experian.

Maximum Points it Can Cost

The maximum number of points a consumer can usually lose is 125, according to Ellen Cannon of Bankrate.com. This would probably only occur to a consumer with a score of 780 before the creditor declares the account settled and if the account had yet to go to a collections agency or been written off as debt.

Time Frame

A settled account can only affect a borrower's credit score for seven years under the Fair Credit Reporting Act. However, the credit bureaus weigh negative items less heavily as they go on. While any settled account hurts a score more than just about any other item, the effects become much weaker in the FICO scoring system after two years.

Tip

Consumers usually do not need a debt settlement and a debt settlement company may do more harm than good. Debt settlement companies often suggest purposely missing payments to make it look like the borrower is about to file bankruptcy and scare the lender into accepting something rather than nothing. Also, forgiven debt is taxable income. The tax implication could be far worse than the original debt, because unpaid taxes are nearly impossible to discharge and unpaid tax liens can stay on a credit report forever. Lenders usually have a hardship program, such as deferred payments, if the borrower warns the creditor of problems before the account is too delinquent.