Debt Settlement: How It Works And Risks You Face
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Debt settlement means a creditor has agreed to accept less than the amount you owe as full payment. Once it accepts that deal, the creditor cant continue to hound you for the money and you dont have to worry that you could get sued over that particular debt.
It sounds like a good deal, but debt settlement can be risky:
Debt settlement can destroy your credit.
Reaching a settlement can take a long time to accomplish often between two to four years.
It can be costly.
Even if you are successful at debt settlement, it can take years and you may discover you owe tax on any forgiven debt. And if you use a debt settlement company, youll pay fees. It is a last resort.
Rebuilding Credit After A Debt Settlement Program
When you finish paying off credit card debt through the program, it remains a part of your credit history for six years. While debt settlement companies help you get out of debt, it can hurt your credit score. Depending on your prior score, your bad credit can be worse off.
However, its better for the creditors to receive compensation partially than not at all. Besides, you can rebuild your credit with proven techniques.
How Long Does Debt Settlement Stay On Your Credit Report
A settled debt with no late payments will stay on your credit report for seven years from the date it was settled accordingly to regulations outlined in the Fair Credit Reporting Act . A late payment on an account is called a delinquency. Delinquencies are reported to the credit bureaus after 30, 60, 90, and 120 days of being late. If you do make a late payment, it will stay on your report starting on the date it became a delinquent account and was never current again.
If the account that you settle is a collections account, then the negative item in your credit report would remain for seven years from the date the remaining balance was discharged.
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Does Credit Card Settlement Affect Credit Score
Since credit card settlements indicate your irresponsible financial behavior, and your inability to manage/repay your credits, it is as bad for your as financial bankruptcy is. Credit card settlement drastically reduces your credit score and hence, almost eliminates your chances of getting any form of credit in your near future. You might need several years to recover from your credit card settlement. This is also majorly because a credit card settlement is recorded as a black mark in your credit history which lasts upto a minimum of 7 years.
Impact Of Missing Payments
Most debt settlement companies require you to stop making payments on your debt while they work with the creditors to settle the amounts. This will likely bring your credit score down because payment history is typically the most important factor in determining your credit score. Make sure you work with a debt settlement company that is reputable since you are taking a risk by stopping payments on the accounts.
Consumers should be extremely cautious when using a debt settlement firm, said Lori Stratford of Navicore Solutions, a nonprofit National Foundation for Credit Counseling agency based in Manalapan Township, N.J. Most of these agencies require payments be made to them, while the bills continue to fall further behind.
Avoid any debt settlement agency that charges fees prior to the creditors agreeing to the settlement, Stratford advised.
There is no government plan that requires creditors to settle debt, so if promises like this are made or advertised, stay away from that agency, she said. Make sure you have everything in writing.
The FTC echoes that warning: Debt relief service scams target consumers with significant credit card debt by falsely promising to negotiate with their creditors to settle or otherwise reduce consumers repayment obligations. These operations often charge cash-strapped consumers a large up-front fee, but then fail to help them settle or lower their debts if they provide any service at all.
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How Long Will A Debt Settlement Affect Your Credit Score
How long a debt settlement affects your credit score depends on who negotiates the debt settlement with your creditors. If you negotiate the settlement yourself, or you pay to use the services of a for-profit company, the settlement notation will remain on your credit report for 6 years from the date your payment is processed. While it affects your score more in the early years, as you work to build up other good credit, over time it impacts your credit score less and less.
However, non-profit credit counselling agencies have special arrangements with the credit bureau companies whereby we can instruct that the settled debts be removed from your credit report 2 years from when your payment is processed. To learn more about how our debt settlement programs work, contact us for a free, confidential appointment with one of our Credit Counsellors. They can explain the program and see if it might be an option for your situation.
Send A Goodwill Letter To The Lender
If you feel like going directly to a credit bureau isnt the right attack, then you can send the lender a goodwill letter directly.
This letter is a polite way to ask if a lender will remove the settled account from your credit history.
This differs from a dispute because you are asking nicely to have the settled account removed and not stating any inaccuracies.
Sending a goodwill letter is ideal for people that defaulted on a loan due to personal injuries or illnesses.
Keep in mind that creditors will look at the history of the account and try to see if you made any attempts to get caught up after one of these circumstances.
They may use this information to make a decision on your account.
At this point, you can offer to make the full payment or try to find a middle ground.
With the lender by settling on an amount that is less than whats owed.
After finding a way to pay in full or at least some, the lender should remove the account from your credit report.
Keep in mind the negative effects of the account will be removed since it is considered to be paid, but the ragged payment history will still be available on your account.
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Myth No : Using A Debt Settlement Company Wont Cost Much
The truth: Debt settlement companies will charge you on a percentage basis, usually, a portion of your total debt or of the amount forgiven.
For example, Clear One Advantage charges a percentage of the total debt the consumer enrolls in the program. However, the company doesnt collect until it has made a settlement and the customer has approved it, Gordon says.
A legitimate company should never charge upfront fees. Not a one-time fee nothing, Gordon says.
Finally, debt settlement might cost you at tax time, too, because Uncle Sam may get a cut. The amount of debt that is forgiven by a lender is often taxable.
Settling An Account Is Better Than Not Paying At All
Although settling an account is considered negative, it won’t hurt you as much as not paying at all. And, if you are planning on making a major purchase, such as buying a home, you may be required to either settle or pay in full any outstanding delinquent debts before you can qualify for a loan.
If paying the debt in full is not an option, settling the account is typically more beneficial than letting it go delinquent or, worse, to default.
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Why Is Improving Your Credit Score After A Debt Settlement Important
Improving your credit score after debt settlement and maintaining a good credit score in the United States is extremely important because credit scores play a great role in our ability to do things, such as buy a home, rent an apartment, and finance a car.
This is so because your credit score represents your ability to pay back the money that you borrow from lenders and creditors. Lenders, creditors, and landlords often look at your credit score to determine the risk that you pose to them. Usually, the higher your credit score, the more favorably youre viewed by them because you pose a lower risk of defaulting on your obligations.
Also, the higher your credit score, the better the terms you will qualify for. For example, if you have a very good or excellent credit score, you will qualify for the best interest rates on credit card and loans, and youll qualify for higher credit limits. Having a low credit score will make it difficult for you to find housing and credit card with good interest rates.
The credit reporting bureaus dont provide the exact method of calculating your credit score, but they do provide some of the factors they look. The following factors play a role in calculating your credit score: payment history, credit utilization, age of your accounts, your credit mix, and whether any derogatory information appears on your credit report. So, how do you improve your credit score after debt settlement? We will discuss this in much detail below.
Settling Credit Card Debts And Its Implications For Your Credit Score
Its probably useful to begin this article by explaining credit card debt settlement.
Settling credit card debts is just one of the avenues open to you when you want to get back on top of unmanageable debt.
It works by reducing the amount you need to pay, and its a form of debt forgiveness.
That basically means that your creditor agrees to write off some of the balance you owe.
Heres an example of credit card settlement in action:
- Jenny has gotten herself into a bit of a mess with one of her credit cards. Shes been using the card for years to pay for all sorts of day-to-day expenses and household bills. She began to realize the situation wasnt ideal a long while back, but she put off dealing with the issue because she was busy and couldnt see any easy ways out
- Everything was fine until Jenny realized shed allowed the balance to really mount up. Shes been managing to service the minimum monthly repayments up until now barely. The amount on the card has now reached a level where the interest is too much for her to pay
- Jenny works full-time, but she also has a car loan and a mortgage. Shes finding that she cant afford to buy food and keep up with the payments on her home and vehicle because of the credit card
- Jennys credit card balance is just below her $20,000 credit limit. Her credit counsellor is confident that she can arrange to pay off approximately $12,000 of that, get the credit card account closed, and move on with her life
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Beware Of Debt Settlement Scams
Some companies offering debt settlement programs may engage in deception and fail to deliver on the promises they make for example, promises or guarantees to settle all your credit card debts for, say, 30 to 60 percent of the amount you owe. Other companies may try to collect their own fees from you before they have settled any of your debts a practice prohibited under the FTCs Telemarketing Sales Rule for companies engaged in telemarketing these services. Some fail to explain the risks associated with their programs: for example, that many consumers drop out without settling their debts, that consumers credit reports may suffer, or that debt collectors may continue to call you.Avoid doing business with any company that promises to settle your debt if the company:
- charges any fees before it settles your debts
- touts a “new government program” to bail out personal credit card debt
- guarantees it can make your unsecured debt go away
- tells you to stop communicating with your creditors, but doesnt explain the serious consequences
- tells you it can stop all debt collection calls and lawsuits
- guarantees that your unsecured debts can be paid off for pennies on the dollar
What Sort Of Debt Should I Settle
Since most creditors are unwilling to settle debts that are current and serviced with timely payments, you’re better off trying to work out a deal for older, seriously past-due debt, perhaps something that’s already been turned over to a collections department. It sounds counter-intuitive, but generally, your credit score drops less as you become more delinquent in your payments.
However, bear in mind that, if you have an outstanding debt that was sent to collectors more than three years ago, paying it off through a debt settlement could reactivate the debt and cause it to show as a current collection. Be sure to get this straight with your creditor before finalizing any agreement.
A debt settlement remains on your credit report for seven years.
As with all debts, larger balances have a proportionately larger impact on your credit score. If you are settling small accountsparticularly if you are current on other, bigger loansthen the impact of a debt settlement may be negligible. Also, settling multiple accounts hurts your score more than settling just one.
Factors That Affect Your Credit Score
Payment history specifically making timely payments on credit card accounts, loans and other lending products ranks as the most important factor in calculating your credit score. If youre looking at debt settlement, your payment history and your credit score have undoubtedly been battered already.
At FICO, the biggest producer of credit scores in the U.S., payment history makes up 35% of a FICO score. Its the number one factor among the five factors that FICO considers.
While debt settlement can put you on the path toward healthier finances, it can lead to a decrease in your credit score. Thats because credit card issuers typically close your accounts once your debt has been settled. When those accounts are closed, it could damage two factors that go into calculating your credit score: length of credit history and credit mix.
Length of credit history represents 15% of a FICO score. If your debts are settled and the accounts are then closed, it may reduce the length of your credit history, depending on when you opened those accounts. In turn, that might ding your credit score.
Bottom line: How much debt settlement dings your credit score depends on the current state of your finances and the amount of debt youre settling.
How Debt Settlement Affects Your Credit If You Havent Missed Payments But Still Owe A Lot
The best thing that you can do when faced with significant amounts of credit card debt is avoid missing any monthly payments. That doesnt mean you have to pay your full balance right away, but rather that you must submit at least the minimum payment required by the due date each month. As long as you do so, your account will be classified as Paid on your major credit reports and you will not incur any credit score damage.
Your main objective at this point aside from continuing to make monthly minimum payments will be to chip away at amounts owed. Unfortunately, the only way to do so without experiencing credit score damage is to devise a strict budget with the aid of a and to perhaps use a 0% balance transfer credit card.
If you are willing to sustain some credit score damage in the short term, establishing a debt management plan with a non-profit organization could be a viable option as well, as the credit score ramifications will be far less severe than if you default and try to reach a debt settlement agreement. You should therefore put any thoughts of debt settlement out of your mind.
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The Debt Settlement Process
You may have heard about debt settlement, but its important to understand how it works before you make a decision. Debt settlement starts with a careful analysis of all your debts. Not every loan or line of credit can be resolved by debt settlement. Credit cards and old past-due bills may be good candidates. In many cases, you take this route when youre already behind on the balances.
To start, you create a separate account in which to make deposits, typically instead of making payments to your creditors. Once youve collected a certain portion of your debts, a debt settlement company like Century starts negotiating with your creditors. A successful settlement eliminates the debt, usually for less than what you owe. In exchange, you pay a fee for the service at the end.
Rebuilding Your Credit Score After Debt Settlement
For seven years, your settled accounts are reflected on your credit report. This means that for those seven years, your settled accounts will affect your creditworthiness. Lenders usually look at your recent payment history. There is a high probability that you will be affected for a couple of months or even years after settling your debts. However, a debt settlement does not mean that your life needs to stop. You can begin rebuilding your credit score little by little.
Your credit score will usually take between 6 and 24 months to improve. It depends on how poor your credit score is after debt settlement. Some individuals have testified that their application for a mortgage was approved after three months of debt settlement. Some needed years before they could get a new or loan. It varies case by case and it is difficult to determine the exact timeframe required to improve your credit score. The time it takes to repair your credit score will depend primarily on your credit history.
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