Debt Settlement's Impact on Your Credit Score for Point Reduction

When your debt situation gets to the point that you consider a debt settlement -- offering a creditor a partial payment to call a debt even -- the impact of a settled account is probably insignificant on your credit score. Debt settlement does the most damage when you go into negotiations with an average or better credit score. If you want to keep as many points as possible, avoid settling, because you cannot predict what effect it will have.

Identification

The impact of debt settlement or any other negative item is unpredictable in the Fair Isaac risk model, because the formula contains dozens of variables. Even small changes in your credit picture can have a large ripple effect. What is known about the FICO model is that negative items do more damage to high scores, because the borrower has more to lose. If you had a score of 780, for example, debt settlement could reduce your score up to 125 points, but usually no more than 65 points on a score of 680, according to Ellen Cannon of Bankrate.com.

Considerations

Lenders usually refuse to negotiate a debt settlement until the lender is seriously delinquent -- typically after about two or three months of no payment. If the lender writes down the account as noncollectable in his ledger or sells it off, the delinquent account will be the most important item. A charge-off or collection account is in line with a bankruptcy, so a settlement on your credit file probably makes little difference, according to Maxine Sweet, head of Experian's Public Education division.

Benefits

Debt settlement's short-term negative impact might be a better long-term solution to poor credit. If you are drowning in debt and frequently miss payments, you score will always be in the dumps. A settled account and any other negatives except bankruptcy and an unpaid tax lien disappear in seven years. Also, you can get a fresh start on your debt profile if you negotiate most of your debts.

Tip

Whether or not you have great credit, go to a licensed credit counselor before opting for debt settlement. The counselor may have choices that satisfy your creditors and protect your credit score. A common option is the debt management plan in which the counselor talks all of creditors into a single payment, which the manager handles and divides amongst them.