The simple answer to this question is yes, the process of settling an account with a creditor can sometimes hurt your credit, but not because you settled the debt. Moreover, availing yourself of a debt settlement opportunity will always be better defaulting on the account.
Let’s look at it in a bit more depth.
What is Debt Settlement?
Debt settlement is a practice that permits you to pay a lump sum that’s less than the amount you owe to “settle” or resolve your debt. Settlements are negotiated with the debtor’s unsecured creditors.
Such creditors will usually accept such an agreement over the possibility of continued nonpayment, especially if your credit report is littered with outstanding balances and you are at risk of filing for bankruptcy.
Does debt settlement hurt credit? In a word — yes, sort of. Debt settlement does hurt your credit temporarily because you usually go past due on your bills. However your credit score generally won’t fall because you settled a debt.
You also may be required to either settle or pay off any outstanding delinquent debts before you can qualify for a loan for a major purchase such as a house.
How Debt Settlement affects your credit
If you’re more than 180 days behind on your credit card payments, your credit report will indicate a default. By now, you’ve likely already accrued ample credit-score damage, so debt settlement isn’t as risky for you.
If you’re between 30 and 120 days late on your credit card payment, that’s too soon for most credit card companies to discuss debt settlement. Creditors typically wait until customers default or come close to the 180-day delinquency mark before even entertaining a conversation about debt settlement.
Any late payments will remain on your credit report for seven years from the first delinquency date. If you had no late payments — but settled because you couldn’t afford to keep making them — the account will be on your report for seven years from the settlement date.
How to improve your credit score
While no credit score improvements will happen overnight, if you’ve had a history of debt problems, you’re now making moves to solve them. A positive initial step is to bring any past due accounts current.
Going forward, you should also make all loan or credit card payments on time. Your payment history is one of the most significant aspects of your credit report. If you ever find yourself unable to make a timely payment — even the minimum amount required — discuss options with your lender before the account turns delinquent.
After you’ve gone through debt settlement, in the future, keep balances low on revolving accounts. Your utilization rate — the amount of credit being used relative to your overall credit limit — is the second-most key factor in credit scoring.
Remember the Greater Good
The aim of any debt settlement plan is to eliminate some of your debt, especially if you can’t afford to pay the full balances. That may call for you to temporarily sacrifice your credit score for the sake of getting out of debt.
So, does debt settlement hurt your credit? Yes, the process can, but not forever. When a debt is settled, a creditor will update your credit report to indicate a “settled” status. Although such a standing is somewhat better than “unpaid,” any payment ranking other than “paid as agreed” can hurt your credit. However, once you have wiped out your debt balances, you can begin rebuilding your credit score.
