People often ask how debt settlement affects credit scores. The process always hurts ratings but is worth it for the most qualified borrowers.
Individuals experiencing true financial hardship find the impact on credit ratings is not very big and does last very long. In addition, they enjoy debt relief at the end of the process.
Consumers who are able to pay on time often experience the opposite. The impact on ratings is much larger and lasts much longer. Alternative solutions work better for them.
- How much it affects ratings and how long it stays on reports
- The length of time it takes scores to improve after completion
- Impact on ratings versus consolidation, bankruptcy, counseling
How Debt Settlement Helps Your Credit Score
Debt settlement does little to help your credit score. People must first endure a long period while negative information about non-payment appears on their consumer report. However, at the end of the process, they often owe less money.
People must choose between saving money and protecting their ability to qualify for new loans.
How Long it Takes to Improve
Do you qualify for debt relief? It does not take very long for your credit score to improve after a debt settlement. Expect a slight uptick shortly after the bank reports the paid in full for less than the full amount status.
- Before the conclusion – the lender has not agreed to anything. They report a major derogatory status such as a charge off, or collection account. You are still delinquent.
- After the conclusion – the lender has agreed to accept less than full payment. They report a paid for less than the full balance status. While still a negative mark, you are no longer delinquent.
Credit ratings continue to improve after debt settlement as time passes. You now have a historical delinquency opposed to an open one. This is better. The more time that goes by, the more your score will increase.
Expect the biggest improvement in ratings once the derogatory history disappears from your consumer report – 7 years after the date of first delinquency – not 7 years after the conclusion of the process.
Versus the Alternatives
Debt settlement is sometimes good for your credit score when compared to the alternatives. Other times the alternative is better – if you can qualify.
Taking out a debt consolidation loan is often better for your credit score versus debt settlement. However, this option costs much more– if you can find a willing lender.
A debt consolidation loan allows a consumer to take money from one lender to pay off another. The borrower often gets lower monthly payments by extending the repayment term. It is easier to stay current with lower monthly payments. However, interest has more time to accrue and you must repay the entire balance in full.
The qualifications for debt consolidation loans prevent many borrowers from using this strategy. Many lenders will shy away from approving borrowers behind on payments. In addition, applicants must show sufficient income and demonstrate a reliable work history.
Settlement vs Bankruptcy
Debt relief is always better for your credit score versus bankruptcy. A bankruptcy ruins ratings for much longer because of when they first appear on a consumer report.
Consumers often contemplate filing bankruptcy years after the date of first delinquency on unsecured accounts. In addition, it takes time for a bankruptcy to work through the court system. Bankruptcies age from your consumer report based on the court filing date, rather than the date of first delinquency.
- Bankruptcy Chapter 13 – 7 years
- Bankruptcy Chapter 7 – 10 years
With a bankruptcy, a consumer first endures years with late payments displaying on a credit report. Afterward, a chapter 13 or chapter 7 stays on file for 7 to 10 years.
Credit counselors who put together a debt management plan are often better for your credit score versus debt relief – however, it often does not matter.
The non-profit credit-counseling agency will negotiate with banks to lower monthly payments by extending the term. The bank will report a comment along with the account that reads that the consumer is part of a debt management plan. This comment displays on a consumer report.
The debt management comment on reports does not affect risk scores. The equations ignore the comment and focus on actual behavior – the amount owed and payments.
Many debt management plans discourage participants from applying for new loans. It makes no sense to borrow additional money when a person is struggling to pay down what they already owe. Therefore, the impact on ratings is irrelevant.
Paid in Full
Paying any charged off balance in full is always better for your credit score versus debt relief. When the status shows as “paid in full” it indicates that you eventually met all your obligations. “Paid for less than the full balance” is a more severe status.
However, debt settlement is often better for your wallet than paying in full. For example, if you owe $20,000 and reach a 50% settlement, you save $10,000.
Every option has a price.
How Debt Settlement Hurts Your Credit Score
Debt settlement programs will always hurt credit scores. The process causes two sets of negative payment history information to appear on your consumer report.
- Major derogatory statuses during the escrow payment phase
- Paid for less than full balance status after a successful negotiation
This consequence is least impactful for the borrowers most likely to experience debt relief.
How Much Settlement Hurts
The basic qualifications to enroll in a debt settlement program helps us determine how much you might hurt your credit score. Eligible participants owe more than $10,000 in unsecured obligations (credit cards, medical debt, and personal loans) and they are experiencing financial hardship.
People making on-time payments are not experiencing financial hardship. A debt settlement program is not a good fit and would be very bad for your credit rating.
- Creditors have no reason to forgive a balance when you make payments on time.
- You must purposely log negative payment history onto your consumer report.
- This ruins your chances of opening new borrowing accounts for a long time.
- Request a debt consolidation loan to lower monthly payments instead.
On the other hand, individuals experiencing financial hardship already have a very poor credit rating. They are already late on payments, with little hope for recovery. Now that you have already ruined your rating with late payments, you have little to lose, and much to gain!
- Little to lose – In the early stages, the enrollees stop making payments to creditors. They divert money into an escrow account.
- Minor delinquencies often become major derogatory marks.
- This pushes an already poor rating even lower.
- It does not matter. You were not qualifying for a new loan anyway.
- Much to gain – after accumulating sufficient funds in the escrow account and starving the banks of payment, they are motivated to compromise.
- The banks may accept less than full payment to absolve your debt
- Collection calls and wage garnishment stops
- You save thousands of dollars in forgiven debt
How Long Debt Settlement Stays on Credit Report
Determining how long debt settlement stays on your credit report is not as important as it seems. Any negative experience stays on your consumer file for 7 years – counting from the date of first delinquency on each account.
The process takes time, and many consumers begin the process after they have been delinquent for quite some time. Therefore, this shortens the length of time the final status remains on file.
Age of Existing Delinquency
Consumers experiencing financial hardship may have fallen behind on payments months or years before beginning the process. The clock begins ticking on the date of first delinquency, and not when they start a program or when the bank agrees to forgive a portion of the balance owed.
Length of Process
The average consumer takes 3 to 5 years to accumulate enough money into an escrow account before a bank agrees to forgive a portion of the balance. During this time, the lender will report a negative status: charge-off, collection account, etc.
Total of 7 Years
The banks agree to a settlement at the end of the multi-year process. In order to determine how long the paid for less than the full balance status appears on your credit report – subtract the previous time other derogatory marks appeared on file from 7 years.
The length of time the final status appears is different for every person. However, the total time negative marks display always totals 7 years and does not extend beyond.
Years Appearing on File
|Before Start||During Escrow||Paid-Settled|
Removing Settled Accounts
Removing settled accounts from your credit report is not realistic – unless you can prove the information does not belong to you. If the data is accurate, you just have to wait it out.
For many consumers, the waiting time is not nearly as long as they think – as you can see from the chart above.