Does Settling a Loan With a Debtor Negatively Impact Your Credit Score?

Consumers with a higher credit score are considered to be less of a credit risk. The higher your score, the better. FICO credit scores go from 300 up to 850. If you owe unpaid debt on a loan, it may be tempting to settle that debt with the lender but you should understand if that settlement will negatively impact your credit score.

Scores

In order to understand how settling a loan can impact your FICO credit score, you must understand how a credit score is determined. According to FICO, how well you pay your bills, the length of your credit history, the amount of debt you have, the types of credit on your report, and the amount of recent debt you've applied for all factor into your score's calculation. Your score is not a stagnate number, but changes as the data within your credit report changes.

Significance

Settling a loan means you pay the lender of that loan less than the amount owed. A lender may be willing to accept less rather than get nothing at all from you. This is especially relevant if you're behind on your loan payments. A paid-but-settled account is reported to the bureaus as "settled in full," not as "paid as agreed." This is a negative on your credit report. According to John Ulzheimer of CNBC, credit-scoring models, like the one used by FICO, view settled accounts as a negative because you did not honor the original terms of your loan agreement by paying the lender back all that was owed.

Considerations

When you settle the loan, there is a portion of the debt that the lender does not receive payment for. The lender may forgive this amount and write it off as a loss on its taxes. The lender will then report that balance to the Internal Revenue Service as income to you. The lender will send you a 1099 form for you to include on your next tax return. The amount listed on the 1099 counts towards your total income, which means you may or may not owe taxes on it, depending upon your tax situation.

Credit Reports

Thirty days after you've made payment to the lender and settled the loan, visit AnnualCreditReport.com and order a free copy of your credit report. The Fair and Accurate Credit Transactions Act gives you the right to receive one free copy of your report from Experian, Equifax and TransUnion each year. Ensure that the loan is reporting accurately. If it isn't, the Fair Credit Reporting Act gives you the right to dispute it with the bureaus and have it corrected within 30 days.