A credit score tells potential lenders how creditworthy you are. If you've settled a part of your debt, you have effectively defaulted on that part of the loan. This makes you a bad risk for other lenders. Your credit score will plummet. However, if you are financially responsible over a period of several years, this will matter less. After seven years, the debt settlement will disappear from your credit report and stop factoring into your credit score.
Debt Settlement
With debt settlement, you pay off a lump sum of your debt in exchange for the lender forgiving the remainder. Lenders do not forgive debt out of the goodness of their hearts. They will only do it if they believe there is no other way to get their money back. Forgiving part of the debt is better than having the debtor file bankruptcy and default on the whole amount. Once the debt is forgiven, you will have to pay income tax on that amount. The IRS considers forgiven debt the same as other forms of income.
Debt Settlement and Credit Scores
The way the lender knows that you cannot pay off the debt is by looking at your income and your credit score. To qualify for debt settlement, you will have to let your credit score drop significantly. It will take several years to rebuild your credit history to the point where you can get a car lease or a mortgage at a reasonable interest rate. The debt settlement will matter less with each subsequent year, but will not disappear from your credit report until seven years have passed.
Bottom Line
If you are thinking about debt settlement, chances are that your credit history is already damaged. Debt settlement is not an option for people who simply don't want to pay back their debts. It's for people who want to but cannot. If you are in that situation, your credit score is probably already low. Debt settlement will drop it further, but it will not matter as much as if your score was in the excellent range.
Alternatives
Bankruptcy is a common alternative for people considering debt consolidation. Bankruptcy will have a greater effect on your credit score. It will also stay on your credit report for three years longer than debt settlement. Another option is to negotiate with the lender not to erase debt, but to come up with a new repayment schedule that you can afford. This option is better for the lender and for your credit history.
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