Will Settling a Credit Debt Affect My Credit Score?

People having trouble making minimum payments on their credit cards each month may consider debt settlement attractive. While debt settlement is legal, it's developed a negative reputation as a result of settlement scams and its harmful effect on your credit rating. Before opting for debt settlement, you should work with a credit counselor to determine the extent to which debt settlement will impact your financial situation.

Definition

Debt settlement is an arrangement in which your creditor agrees to accept a one-time payment for a percentage of your debt balance as payment in full, usually to prevent bankruptcy. According to SmartMoney writer Aleksandra Todorova, the one-time settlement payment is usually between 20 and 75 percent of your total balance. Creditors typically agree to a settlement only if you are in danger of filing for bankruptcy, so you typically must be behind on payments for a creditor to consider settlement.

Credit Score

The effect of debt settlement on your credit score depends largely on the other information contained in your credit report. If you have a number of delinquent accounts and negative marks on your report, your score is likely to drop less than if your credit report is fairly clean. This is because people with a lot of delinquencies probably already have a low credit score, so the score cannot drop much lower.

Reporting

Credit reporting bureaus list debt settlements in one of several ways on your credit report. A debt settlement may be listed as "Debt settled for less than the full amount due" or "Partial payment accepted" or "Settlement," according to Bankrate writer Leslie McFadden. Having this listing on your report may affect your ability to obtain credit, because lenders are reluctance to issue loans to people who have a history of being unable to pay off debts in full.

Considerations

You typically should work with a reputable credit counselor, not a debt settlement company, because debt settlement companies often charge high fees and sometimes provide questionable services, according to the SmartMoney website. A credit counselor works with you to establish a budget and may offer you other debt solutions, which may be less damaging to your credit score. Visit the National Foundation for Credit Counseling (NFCC) website for a list of NFCC-approved counselors in your area.