Does Negotiating My Credit Card Debt Have a Negative Impact on My Credit?

It is not uncommon for credit card companies to settle debt for 50 cents on the dollar or less, but debt settlement could ruin your credit for years to come and not help your situation as much as you think. Lenders will report your account as settled in some fashion, and you could have to deal with negative consequences from the IRS, too.

Identification

Negotiating your credit card debt for anything less than the original balance has a negative impact on your credit report. Settled accounts are a major delinquency in the FICO credit scoring system. A person in the highest tier of scores -- above a 780 -- would see a drop between 105 and 125 points, according to Ellen Cannon of Bankrate.com.

Considerations

You probably won't see a significant negative impact to your credit rating because you likely already have many missed payments. It is often the delinquencies leading up to debt settlement that do the most damage to your credit report. You recover some of the points you lose from debt settlement by eliminating debt from your record, as debt counts for 30 percent of your FICO credit score.

Taxes

If the credit card company forgives any portion of your bill, the Internal Revenue Service taxes the forgiven debt as if it were income. Thus, you must factor in taxes when you negotiate a debt settlement. For example, imagine the credit card company forgives $15,000 in debt. If you fell into the 30 percent tax bracket, you would owe $5,000 in taxes. In case you cannot pay your tax bill, the IRS might put a lien on your property, unless you worked out a payment agreement. A tax lien or levy is another negative mark on your credit history.

Tip

Debt settlement is usually not the best option for most people, according to Liz Weston of MSN Money Central. You should schedule a session with a credit counselor before you start negotiating a credit card settlement. For example, you might be able to pay off all creditors with one monthly payment through a debt management plan, or bankruptcy might be the best option.