How Does a Negotiated Payoff Amount Affect Your Credit Score?

When you have not made payment on a debt in a while, sometimes the creditor is willing to negotiate a payoff amount that is less than what you owe. The creditor is motivated by trying to get at least partial repayment, instead of having to write off the whole debt as unpaid. Although this might seem like a good deal for you, a negotiated payoff amount lowers your credit score.

Settled Account

After you negotiate a payoff and pay the agreed amount, the creditor reports the account as settled. The exact phrasing varies slightly, but it communicates that the creditor accepted a partial payment on the debt. This will lower your credit score by anywhere from 40 to 140 points, depending on what your score was before you settled the debt. The higher your score before the settlement, the more it will fall. The reasoning behind such a large drop is that a settled account makes you a very risky borrower for other creditors because you have a history of not fully repaying your debts.

Duration

A settled account will remain on your credit report for seven years after the date of the last activity on the account. It will affect your score for the whole time, but the effect will be largest immediately after you settle and smallest at the end of the seven years. This is because your credit score is weighted more heavily toward the most recent information.

Considerations

If you are settling an account with a collection agency instead of the original lender, you might be able to prevent your credit score from dropping. Although you can't necessarily remove the notation that the original account went into default, the collection agency can take the collection account itself off your credit report. In the negotiations, include the requirement that the collection agency remove the account if you pay it off. You might have to pay a slightly higher amount than you would without this requirement, but if you care about having a good credit score, it might be worth it.

Improving Your Score

Managing credit responsibly after your negotiated payoff can help your credit score bounce back more quickly. You probably have more money available in your monthly budget now that you do not have to make payments on that debt, so take advantage of this to pay down other existing debts, especially on credit cards. This improves your credit utilization ratio, which compares the balances on your cards to the cards' limits. If you don't have any credit cards, you could get a new one and start using it regularly for small purchases you can afford then pay it off in full at the end of each month. This helps develop a consistent payment history and improves your score.