How Settling a Credit Card Debt Affects Your Credit Score
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Settling a credit card account will resolve your debt, but before you commit to this course of action, please read on to learn more about the negative impacts a debt settlement will have on your credit score, alternative debt-relief options, and how you can turn debt relief into a positive opportunity to rebuild your credit over time.
Written by the Upsolve Team. Legally reviewed by Attorney Andrea Wimmer
Updated September 15, 2020
If you’re considering entering into a debt settlement program to achieve a $0.00 balance and a clean slate, you should be aware of the negative effects that debt settlement will have on your credit score and future credit opportunities. Settling a credit card account for less than you owe will immediately resolve your debt, but you will then need to invest time into rebuilding your credit score.
You can rebuild your credit after settling debt, it will simply take some time and effort to do so. Before you commit to this course of action, please read on to learn more about the negative impacts a debt settlement will have on your credit score, alternative debt-relief options, and how you can turn debt relief into a positive opportunity to rebuild your credit over time.
Settling a Credit Card Debt Can Lower Your Credit Score
Debt settlement affects your credit score. Because the credit card company takes less money than is owed, your credit score will be temporarily lowered because you won’t pay your debt in full. The amount that your credit score will drop will depend on your personal financial situation. Chances are that your credit score took a dip as soon as you fell behind on your monthly payments.
Entering into debt settlement will drop your score lower than it is now. However, by resolving your debt, you’ll place yourself in a position to improve your score over time. If you ignore your debt, your score will drop lower due to your default and any collection actions taken against you. As a result, tackling your debt head-on will help your credit score in the long run, even if it lowers your score in the short-term.
Debt Settlement And Other Debt Relief Options
The process of debt settlement gives you the option to negotiate with credit card issuers to settle debt with a lump sum payment that is less than the total amount due on your account. Note that you may have to pay taxes on the forgiven debt of the settled debt if it’s over $600. (The forgiven debt is the amount of the original total debt that you didn’t pay.) However, if you don’t have the funds available to make a lump sum payment or you don’t want to mess with the tax consequences, you have other options available to settle credit card debt.
To explore options other than debt settlement, consider credit counseling. Accredited, nonprofit credit counseling agencies offer a free credit counseling session to anyone interested in taking advantage of this service. Credit counselors are trained in personal finance. You can talk to them about working with a debt settlement company, entering into a debt management plan, pursuing debt consolidation, and filing for bankruptcy. They will provide you with personalized guidance after learning about your unique circumstances.
A debt management plan (DMP) gives you the option to have your debt paid in full over time (often with a lowered interest rate and lower monthly payment minimum) by making one lump sum monthly payment to a nonprofit credit agency. The agency will distribute your funds to your numerous creditors until the debt is paid in full. DMPs and debt settlement plans are programs that work with unsecured debt, not secured debt.
If you have federal student loans, you may qualify for a direct consolidation loan. If you have good credit, you can get a low-interest rate credit card and transfer the credit card balances of your cards with high interest rates to the new credit card account with a low interest rate. This is known as debt consolidation.
Bankruptcy goes through the courts, so it’s a safe debt relief option. But before you sign up for any other type of debt relief service, check with the Federal Trade Commission (FTC) and Consumer Financial Protection Bureau (CFPB) for scams and verify the reputation of any company you’re interested in working with the Better Business Bureau (BBB). Your credit score will be a lot worse if you end up a victim of fraud.
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Credit Card Settlement Shows Up On Your Credit Report
After a debt settlement for your credit card, there will be an explanation on your credit reports from Experian, TransUnion, and Equifax, that the debt was “settled for less than the full amount owed,” but the credit card settlement will also give you a zero-dollar balance. The zero-dollar balance is good for you, even though the partial repayment of the loan will cause your credit score to suffer temporarily.
Loan companies look at how much money is owed on outstanding debt before they make a decision regarding whether to extend you new or additional credit. Because of your credit card settlement, you won’t have an outstanding balance. That will improve your chances to qualify for a loan overall. Bankruptcy will also leave you with a $0.00 balance on credit card debt if the debt is discharged in bankruptcy.
Many actions result in negative credit reporting, such as late payments on certain monthly bills, charge-off accounts, collection agency debts, filing bankruptcy, and settling debt for less than the amount owed. The extent to which negative information on your report after settlement will affect your overall score and credit history will depend on your financial history, the reporting habits of the agencies, the status of the settled debt and your other outstanding debts (if any), and current laws and regulations.
How Long Will Negative Information Be On My Credit Report?
When you settle a debt for less than the total amount owed, that status will likely remain on your credit report for 7 years. That’s also how long a completed Chapter 13 bankruptcy stays on your report. A Chapter 13 bankruptcy lets you make affordable payments on your debt over either a 3 or 5 year period. If the Chapter 13 case is not completed to discharge, it will stay on your report for 10 years. A Chapter 7 bankruptcy also stays on your credit report for 10 years, but this process allows your debt from credit cards and other eligible unsecured debts to be discharged without having to make payments on that debt. When bankruptcy debt is discharged, you’re officially no longer responsible for that debt anymore. If your debt is more than you can afford to pay, you could become debt-free after filing a successful bankruptcy case.
Ordering A Free Credit Report
Each of the major credit bureaus is legally required to give you a free credit report annually, although you may have to pay extra to access your credit score. Checking your credit report once per year can help you identify fraud and check for mistakes made by credit reporting agencies. It’s not uncommon for credit reports to contain inaccurate or incomplete information that can make your credit score worse than it should be. These inaccuracies can be fixed by you or a credit repair lawyer.
Rebuilding Your Credit After Debt Settlement
A negative entry on your credit reports from Experian, TransUnion, and Equifax can impact your overall FICO score, but a dip in your score doesn’t have to last forever. With time, you can bring your credit score back up after completing a debt settlement or taking advantage of an alternative debt relief option. When you settle your debt, there will be no more new missed payments reported and you will benefit from a zero-dollar balance. The same is true if you file bankruptcy. You can also rebuild credit after bankruptcy.
If all your future payments are made on time, your credit score should improve steadily. Credit reporting agencies also look at the credit utilization ratio, which means they compare how much debt you have outstanding and how much you have available. Getting a secured credit card or a small installment loan could improve your credit utilization ratio. Just be sure to keep your new charges under 30 percent of your available credit and make your payments on time.
Your credit score is determined by an analysis of your past payments, the total amount owed, credit inquiries, how long you’ve had credit, and new credit that has been recently obtained. Since your total amount owed goes down after debt settlement or bankruptcy, your credit score could improve quickly over time. A FICO score below 620 means you’ll probably pay higher interest rates and higher annual fees to get new credit, but it doesn’t mean you can’t get credit.
Settlement of your credit card debt will impact your credit score—but with persistence, determination, and a little bit of luck, you’ll be able to raise your score to new heights. Settling debt for less than the total amount owed is better for your credit than ignoring your debt, but it’s worth taking a closer look at bankruptcy if you can’t afford to settle your debt.
In a Chapter 7 bankruptcy, your credit card past-due debt can usually be completely discharged, debt collectors won’t be allowed to collect, and the impact on your score isn’t quite as bad given the quickness of the bankruptcy process. Talking to a certified credit counselor can help you decide on the best course of action. You can also talk to a bankruptcy attorney about your debt and credit history. If you can’t afford a lawyer’s services, you can potentially use Upsolve’s website app to file bankruptcy without a lawyer. Americans have over $900 billion in debt from credit cards, so you can be confident you’re not alone in your challenge to knock down debt.