Do Debt Relief Settlement Programs Affect Your Credit Score?

Debt settlement can look pretty attractive to a consumer trapped under a mountain of debt. Settlement means you make a deal with your creditors or lenders to pay less than what you actually owe. You'll pay less in a settlement program than if you didn't use this debt-relief method, but not without affecting your credit score.

General Trend

In most cases, debt settlement causes your credit score to drop. Because credit scores involve many different factors, it's impossible to assign a point value to how bad the drop will be, but those with good to excellent credit scores tend to see more of a dramatic decrease than those with bad credit already, according to online resource PayingPaul.

The Payment Problem

When you enter debt settlement, the debt settlement company usually advises you to stop paying your creditors. You pay the debt settlement company until you've met the company's fees and have provided enough funds to cover the agreed settlement amount. This means you can be paying on your debt and your creditors, who aren't seeing the payments, can report you as delinquent or late to the credit bureaus. If you've involved many creditors in the settlement, these notices quickly can add up and trash your credit. What's worse, these negative items can stay on your credit report for up to seven years.

The Status Issue

Creditors assign debtor accounts a status that appears on your credit report. When you use settlement, the creditor uses a negative status such as "settled" or "paid not as agreed." This drops your score because it shows you didn't meet the original terms of your credit contracts. Additionally, when new creditors look at your account statuses and see settlement, they may hesitate to work with you because of the history of not meeting terms. If you can't get new financing, you can't work on opening new credit lines, improving your payment history or extending your credit history, all of which impact your credit score.

Considerations

It is possible to settle with a creditor without a debt settlement program. If you do this, you may be able to pay the creditor directly, so they don't report you for missing payments. You also can ask that the creditor upgrade your status to "paid," as you technically will be paying off the new owed balance. Both of these approaches may keep your credit score from dropping so dramatically.