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How Does Debt Settlement Affect Your Credit Score?

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In a Nutshell

Debt settlement allows you to pay off a debt for less than the total you owe, but it can lower your credit score. If you compare the permanent benefits of getting rid of a debt burden against the temporary negative aspects of a lower credit score, you might find that debt settlement is a good option for you. If you’re interested in settling your debt, keep reading to learn how debt settlement affects your credit score and whether debt settlement or a different debt relief option is the best for you.

Written by the Upsolve TeamLegally reviewed by Attorney Andrea Wimmer
Updated August 1, 2023

Debt settlement allows you to pay off a debt for less than the total you owe, but it can lower your credit score. If you compare the permanent benefits of getting rid of a debt burden against the temporary negative aspects of a lower credit score, you might find that debt settlement is a good option for you. A report on debt settlement trends from the Consumer Financial Protection Bureau shows there was an increase in debt settlements between 2016-2019, and almost $6 billion worth of debt was settled in 2019.

If you’re interested in settling your debt, keep reading to learn how debt settlement affects your credit score and whether debt settlement or a different debt relief option is the best for you.

Debt Settlement and Your Credit Status

Debt settlement is a repayment method where you negotiate with a creditor to pay less than you owe to close your account and stop collection activity. You or a debt settlement company can negotiate payment options to close your account. You can use the money you have to settle the debt in one lump sum or work out a plan to make monthly payments. Debt settlement is often used with credit card debt. The part of the debt you don’t pay is forgiven debt. If a lender forgives $600 or more it’s considered “canceled debt” and taxable income by the IRS.

Your creditor will report your debt settlement to credit bureaus and it will be recorded on your credit history. If your account is not marked as “paid in full” it will have a negative impact on your credit score. When you apply for new credit, lenders will see that you did not pay that previous balance in full. This will tell them that you might be a risky borrower to lend to. This information stays on your credit report for seven years.

Why Debt Settlement May or May Not Hurt Your Credit Score

Your credit history is outlined in your credit report. Your credit score is calculated from your reported credit history. If you settle a debt, it will appear on your credit report and affect your score. But how much it affects your score will depend on how the creditor reports it.

Your credit score is a three-digit number that lenders use to decide whether they want to approve your credit application. It goes up or down based on your past and current credit activity and ranges from 300 and 850 points. There are different scoring models, so you may have a few different credit scores. A lower score indicates you’ve had trouble making payments, a higher score indicates you’re likely to make payments. Lenders generally want to loan money to people who are likely to pay back 100% of their loans.

How Debt Settlement Affects Your Score

A debt settlement can decrease your credit score by 100 points or more. The amount it drops will depend on your credit history, types of debt, current credit score, and current credit activity. It will also depend on whether the lender reported the settled debt as partially paid or paid in full. When you’re negotiating a debt settlement, ask the lender if they will report the account as “paid in full” as part of the settlement terms. Having an account reported as paid in full, won’t harm your credit score. But if it’s reported as “partially paid,” it will lower your score.

Your credit score is also impacted by your credit utilization ratio or rate. This is how much credit you have available versus how much you’re currently using. The traditional goal is to use no more than 30% of your available credit. Debt settlement will affect your credit utilization rate because the lender will likely close the account after finalizing the settlement. In this case, you’ll have less credit available, which will increase your overall credit utilization rate. And since credit scores also factor in the length of your open accounts, closing an account can also negatively affect this factor. 

How Long Will a Debt Settlement Stay on Your Credit Report?

Settled accounts will remain on your credit report for seven years from the settlement date. Since current credit activity is more important than past activity, the negative impact of your debt settlement on your credit score will decrease as time passes. Every day it will become less important.

In a best-case scenario for your credit score, you’d be able to pay your debt in full and leave the account open. But if you’re considering debt settlement, this probably isn’t possible. Still, it’s more beneficial to settle the account rather than to have an outstanding balance. Either way, time will work to your advantage.

 DIY Debt Settlement vs. Working With a Debt Settlement Company

You can negotiate with lenders to settle debt yourself or pay a debt settlement company to negotiate on your behalf.

Be Wary of Debt Settlement Companies

Unfortunately, not all debt settlement companies are working for your best interest. Some are scams or will mislead you. Some companies will tell you to stop making payments during negotiations, but this can hurt your credit. Also, some debt settlement companies will insist on being paid upfront, but charging upfront fees for debt settlement is illegal.

That said, there are benefits to working with a debt settlement company. They are familiar with lenders and their habits and policies during negotiations. They have valuable insider knowledge, such as which lender may be more inclined to settle and under what circumstances. But many creditors refuse to work with debt settlement companies. If that’s the case, you’ll need to negotiate your debt settlement on your own. Don’t worry — it’s not as hard as it sounds.

Negotiating a Debt Settlement Directly With a Creditor

The CFPB reports that 1 in 13 consumers negotiated a debt settlement between 2007 and 2019. It’s not an unusual practice, and lenders are prepared. Here are some basic best practices to follow before and during negotiations:

  • Know the exact amount you can pay and when you can pay it.

  • Know the exact amount you owe and your current interest rate.

  • Know the name, address, and phone number of the creditor that owns the account.

  • Never start negotiations with the full amount you can pay.

  • Confirm everything in writing.

  • Don’t give out more information than is required. (For instance, they may ask you for your bank account information, but you don’t need to provide them with that information.)

  • Do your research before you begin negotiations.

  • Be patient.

Generally, you can expect a debt settlement to be between 50% and 80% of your debt, but it could be as low as 10% or as high as 90%. Every lender is different. Your lender will want the highest debt settlement percentage and you’ll want the lowest. Negotiations will depend on company policies, your payment history, and whether you have the lump-sum amount or you need a payment plan. Review your budgeting needs and personal finances.

The basic steps to debt settlement negotiations are:

  1. Determine how much you can pay, but don’t disclose this number early in negotiations.

  2. Find out who to contact. Figure out who has permission to negotiate and accept a debt settlement offer.

  3. Ask if they have company policies governing debt settlement and if they’d be willing to settle the debt for less than the amount owed. Also, ask them if they are willing to report the account as paid in full if a debt settlement agreement is reached.

  4. If they offer a different payment plan, take time to decide if this is a better option for you. “I need time to review my options” is a good phrase to practice.

  5. Plan a time to call to start negotiations. Keep a cheat sheet of amounts and percentages in front of you. Be sure to write down names, times, and details. This might help later in debt negotiations. Feel free to negotiate lower payment plans and interest rates if the debt settlement conversation isn’t going your way.

  6. Remember they will constantly try to get information from you that they can use for debt collection purposes. Stay focused on negotiations.

  7. Explore your options and then call back. Repeat until you get an offer that works for you.

  8. Remember they can still sue you and go forward with garnishments and other types of collection activities while you are negotiating.

  9. If an offer is made, confirm that this will settle the account in full, the account will not be sent to collections, the account will be closed, and how it will be reported to the credit bureaus. Confirm the date the payment is to be made. Send a letter confirming the details and ask that they sign it and return a copy to you. If they send a confirmation letter, read the fine print or ask an attorney to review your agreement.

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Debt Settlement vs. Bankruptcy

An alternative to debt settlement is bankruptcy. The biggest difference between the two is that debt settlement doesn’t require you to give up assets. Although you can often make agreements to keep your house and car during bankruptcy, assets can be sold to pay off debts through a court order. When you settle your debt with a creditor, you’re free to decide what to do with your assets, not the court. One advantage of bankruptcy over debt settlement is that filing bankruptcy stops debt collectors from calling. Creditors can still hound you during debt settlement negotiations.

Both debt settlement and bankruptcy will hurt your credit score. Debt settlement and Chapter 13 bankruptcy stay on your credit report for seven years. Chapter 7 bankruptcy will stay on your credit report for 10 years. But that doesn’t mean your credit is ruined forever. You’ll have all your unsecured debt resolved and a clean slate. Your bad debt will become less relevant as you rebuild your credit after bankruptcy. Your bad credit will fade into the past.

If you file a Chapter 7 bankruptcy, your unsecured debts and certain secured debts can be discharged. This means you would no longer owe the debt and you’ll have a $0.00 balance. If you don’t have the money to pay the unsecured debt, you don’t pay your debt. The debt still goes away.

With debt settlement, you must make a lump-sum payment to close the account. Your unsecured debts in bankruptcy can be discharged without any lump-sum payment. In a Chapter 13 bankruptcy, you have the option to make repayment plans for your assets, like your home and your car. You can have your unsecured debt like credit card debt and debt from medical bills wiped clean without a lump-sum payment.

Both debt settlement and bankruptcy can help you wipe out old debt so you can begin to repair your credit. Knowing the extent of your debt, your ability to make a lump-sum payment, and your future plans will help you determine which option is right for you.

Debt Settlement vs. Debt Management

A debt management plan (DMP) is a method of debt consolidation to manage debt so you can improve your credit score. A debt management plan will require making monthly payments for a few years to pay down your debt. You’ll talk with a credit counselor who will help make arrangements for affordable monthly payments. In a debt management plan, debt is consolidated so you can pay one monthly payment instead of having to pay several creditors every month.

Nonprofit accredited credit counseling agencies offer a free first credit counseling session. You can also talk to a counselor about debt settlement and bankruptcy. If you sign up for a DMP, you might have to pay a setup fee or designate part of your payment to go to the agency. You’ll want to evaluate extra fees before signing on to a DMP.

A debt management plan doesn’t require you to come up with a lump-sum payment to pay off your debt, but you do have to come up with the monthly payment to pay down your bills.

A DMP will damage your credit score but depending on your circumstances, probably not as much as a debt settlement program or bankruptcy. Your closed accounts will hurt your credit, but once your accounts are paid and time passes, your credit score will climb back up.

Let's Summarize...

Debt settlement can help you to get rid of old debt, but it will hurt your credit score. Settling the debt on overdue accounts is still better for your credit than continuing to owe money without making payments. You can settle your debt yourself or enlist the help of a debt settlement company. You also have the option to file bankruptcy or enter a debt management plan. All these options will hurt your credit temporarily, but they will all help you get rid of debt so you can get a new start. If you’re having trouble getting a lump-sum payment together, read our next article, “Debt Settlement,” to learn more about debt settlement repayment plans.

Written By:

The Upsolve Team

Upsolve is fortunate to have a remarkable team of bankruptcy attorneys, as well as finance and consumer rights professionals, as contributing writers to help us keep our content up to date, informative, and helpful to everyone.

Attorney Andrea Wimmer


Andrea practiced exclusively as a bankruptcy attorney in consumer Chapter 7 and Chapter 13 cases for more than 10 years before joining Upsolve, first as a contributing writer and editor and ultimately joining the team as Managing Editor. While in private practice, Andrea handled... read more about Attorney Andrea Wimmer

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