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5 Debt Settlement Myths Debunked

Written by John Ulzheimer

There are far too many myths floating around the world of consumer credit. The process and subsequent impact of settling derogatory debts with a debt settlement is no exception to that rule.

A debt settlement is the process where the debtor and the creditor agree on an amount that will satisfy the debt.

Although it has not been “paid in full,” the debt settlement allows for the creditor to be owed nothing more from the debtor.

This is when the myths tend to occur:

Myth #1: Settled debt is deleted from credit reports

Truth — Settled debt remains on a consumer’s credit report until it is required to be removed by federal law.

The Fair Credit Reporting Act, FCRA, governs virtually all things related to consumer credit including how long derogatory items can remain on credit reports. There is nothing in the FCRA that requires that an account be removed from a credit report just because it has been paid or settled. The credit reporting agencies are allowed to continue to report it until the full seven years has passed.

Many consumers attempt to negotiate “pay for delete” settlement arrangements with collection agencies. While “pay for delete” arrangements between consumers and collection agencies are not illegal under the FCRA, those deals violate the service agreements between the collection agencies and the credit bureaus.

If a collection agency gets caught granting “pay for delete” settlements to consumers, then the agency could lose its ability to report accounts to the credit bureaus altogether. Anyone who suggests pay for delete deals are common is misleading you.

Myth #2: Credit reports reflect unpaid balance on settled debt

Truth — If a consumer pays the agreed upon debt settlement offer then the balance of the account becomes zero and the credit report should be updated accordingly.

When a debt settlement, formally known as an “offer in compromise,” is agreed upon by a creditor and paid by a debtor the remaining balance on the account is forgiven. Once the debt has been settled the debtor owes no additional monies on the account UNLESS he or she foolishly agreed to be liable for the deficiency balance.

If the collection agency takes the steps to update the consumer’s credit reports then the account balance should be changed to zero.  Along with the zero balance, a notation along the lines of “settled for less than full balance” will be added to the consumer’s credit report.

Myth #3: Settling derogatory accounts improves credit scores

Truth — The settlement of a derogatory account will most likely do nothing to improve a consumer’s credit scores.

The reason settling a derogatory account almost never has a positive impact on a consumer’s credit scores is because current FICO and VantageScore credit scoring models are built to predict the likelihood of whether a consumer will miss payments in the future.

If a consumer has missed payments in the past, illustrated by the fact that there are settling debts, then the odds are higher that he will miss payments again in the future.

Settling or paying off the balance of an account does not erase the fact that the default occurred and, therefore, usually does nothing to raise a consumer’s credit scores.

There is one exception to this rule. The most current version of VantageScore, called VantageScore 3.0, and the recently announced FICO 9 credit score will ignore all collection accounts that have a zero balance, regardless of whether it was paid or settled. There are some scenarios under those two scoring platforms where the consumer’s scores could go up.

Myth #4: Debt settlement resets 7-year clock

Truth — Nothing can legally cause a derogatory account to remain upon a consumer’s credit reports for longer than seven years from the date of default on the original account, NOTHING.

According to the FCRA, derogatory accounts have a capped time limit for how long they are allowed to stay on a consumer’s credit reports, called a statute of limitations. This is great news for consumers because it means they cannot be penalized for their past financial management mistakes indefinitely.

Once an account has gone into default, which generally occurs after it becomes six months past due, it can only remain on the consumer’s credit reports for seven years from that point. After seven years from the default, the account will be purged from the consumer’s reports.

You can dispute the item, settle it, pay the item in full, or ignore the item and it still cannot stay on a credit report longer than seven years from the date of default.

Myth #5: Debt settlement is a bad idea

Truth — Even if settling a delinquent debt will not improve a consumer’s credit scores it is still probably a smart financial move.

If a consumer can afford to settle a collection account with a debt settlement then they probably should go ahead and do so. Settling defaulted debts with a debt settlement is a cost effective way to satisfy the creditor and move ahead with your life.

The alternative of ignoring collection accounts is a horrible idea that can lead to judgments being filed against you if you were to be sued by your creditors.

Not only can settling a debt protect a consumer from the aforementioned “legal” collection attempts, but settlements can also save a consumer a ton of money in the long run and stop those annoying collection phone calls.  Keep in mind that most defaulted debt is sold for pennies on the dollar so even though the collector is accepting a settlement they’re still making several hundred percent on their investment.

About the author

John Ulzheimer

22 Comments

  • MYTH #5: Have to disagree, John.
    I was a credit and collections manager for years, for a very large CA. If people want to move on with their lives, let them do so with their money in their pocket, where it belongs. Just because a debtor has made a mistake, it doesn’t mean making another one by paying greedy and predatory collection agencies. 25 years in the business.

  • A company brought a repo of mine says when I pay half of it they will give me a letter of release but they don’t report it to the credit berry I will have to so you say it still is on my credit for 7 years anyway no need to pay them

  • There were two times in which I had a “pay-to-delete” work. The first was when the debt was still held by the original creditors collection department and had not be sent to a separate collection agency. The second was after being sued for medical bills by a third party collection agency. Since I actually entered a response to the court, we were ordered to complete arbitration. During arbitration I was prepared. Yes, I owed the debt (typical emergency room admittance while I had no insurance). The collection agency filed for way more than what was reported by the “big 3”. It is important to note that the collection agency did not file for recovery of legal bills. I was ready to let a judge decide and not come to an agreement. However, I did concede to pay only what was reported by the credit agencies, and not a penny more. Therefore, it became a part of a stipulated agreement binding to both parties, that if I paid the debt on a very reasonable schedule, the collection agency would remove their entries. I did. They did. They were removed almost immediately. Hope this helps someone.

    • Wanted to add – that it was important to note that the collection agency had not filed for recovery of legal bills, and that their attorney was the one to participate in arbitration. He saw I was willing to see the case to trial, and that the preparation I had done showed him that there was a STRONG possibility I would prevail at trial. No money for his fee, less than 50% chance of winning, he advised the collection agency to agree to the court enforced stipulated agreement. They made a good call.

  • I found it interesting that I just had five collection entries removed for medical bills. These were approaching the 5 1/2 year mark. I had tried and tried to obtain “balance forgiveness” as a “charity write off (as I was unemployed, homeless and really pretty much indigent) with the credit agency the physicians practice had sent the debt to.

    ALL of the other care provider including the hospital had done just that – “charity write off”, but not this one. As a matter of fact, my hospital bill alone approached $190,000.00! I decided to contact the physicians practice one more time. I contacted the head of the business office and described the situation.
    He was understanding, but said that there policy was to not write this off. EVERY OTHER provider had I emphasized. Well, we hung up and after about 2 hours he called me back, and said they had directed the credit agency to remove the entries. Seems as if the new “corporate owner” of the practice had a different policy than the prior “corporate owner” and it was – “if the hospital writes it off so will we”. Wahoo!

    Now the 5 entries are gone and I now have zero collections. My credit score went up a WHOPPING 20 points!WTF. It appears that late payments even if only thirty days, in the last 24 months has a greater negative impact than collections. Of even greater impact is your credit utilization percentage. Mine is outrageous as I use 99% of my huge $6,000.00 aggregate credit limit on 7 cards.
    Paying down my utilization to 20% increases my score by 80 points ( according to the simulators on credit sites). Paying it down to 0% only increases it by 45 points.
    30 % = 75 points. The simulators seem to have a sweet spot at 20% not 0%. Just say’in.

    • The problem with if you owe that much for long period of time and you pay off lump sums, the card issuer often decreases available credit and you end up just as bad score because you still have similar utilization percentage. This happened to me.

  • When I first made my CK acct,I had quite a few derogatory accts. All were medical,some were older than 7 years. One day I log into CK and damn near all of them disappeared. A couple was left on though. So I noticed that every time I pay one off a new one pops up. Has anyone ever had this happen? It’s cray cray.

    • Yes, because someone else has bought the debt and when you thought it would disappear from the report it did NOT.

  • There is nothing in the Law that states that late payments or settlements has to stay on your report for seven years befor it can be removed. Why not publish the law as it is printed.

  • Is this true or not??

    *DO NOT PAY YOUR ACCOUNTS IN COLLECTION*
    *YOU ARE ONLY THROWING AWAY YOUR MONEY*
    Paying a collection company means you are giving your money away to a seedy collection company who strongarms and confuses people into paying these things all the time. Your benefit? Nothing. *Nothing at all*
    The original creditor has already sold the debt to the agency and your credit score is tarnished for 7 years. End of story. Welcome to America!
    Take a swing back at the completely corrupt system that has put you in this situation and DO NOT PAY THE COLLECTION AGENCY EVER.
    Here’s why:
    No matter what happened to lead you to having a derogatory mark — whether it was actual deliberate negligence with a credit card, or completely uncontrollable medical debt — the greedy lawyers and bank lobbyists who set up this idiotic system simply lump all of this debt together in one big “you didn’t pay for this” category on our reports.
    The end result is: you pay higher interest rates for EVERYTHING. Which means *even more money* for the big banks. Good luck getting our government to fix this, too! It benefits those who have all the money, which incidentally are the people who run the government.
    No matter how small the bill, no matter if it was an insurance company’s clerical error / disorganization that led to the mark showing up on your report; It’s there, it’s severely impacting your credit score, and it’s not going anywhere for seven years. Period.
    There seems to be a lot of faux information floating around that you can “pay-to-delete” accounts in collections from your report, but this is completely and totally unsupported by ANY facts. I have *NEVER* seen a single *reliable* reference for how to handle this. If pay-to-delete isn’t analogous to the tooth-fairy, then CreditKarma should offer an integrated service (no 3rd party stuff which just seems like paid advertising) to help with this specific issue. They don’t. Why? Because you can’t do this. Because it’s illegal.
    At a minimum, CreditKarma should have an official “pay-to-delete” info page to dispell these rumors and set the facts straight.

    • There were two times in which I had a “pay-to-delete” work. The first was when the debt was still held by the original creditors collection department and had not be sent to a separate collection agency. The second was after being sued for medical bills by a third party collection agency. Since I actually entered a response to the court, we were ordered to complete arbitration. During arbitration I was prepared. Yes, I owed the debt (typical emergency room admittance while I had no insurance). The collection agency filed for way more than what was reported by the “big 3”. It is important to note that the collection agency did not file for recovery of legal bills. I was ready to let a judge decide and not come to an agreement. However, I did concede to pay only what was reported by the credit agencies, and not a penny more. Therefore, it became a part of a stipulated agreement binding to both parties, that if I paid the debt on a very reasonable schedule, the collection agency would remove their entries. I did. They did. They were removed almost immediately. Hope this helps someone.

    • Thank you for this post. I had a lot of debt that was sold to collection agencies and continue to get harassing calls and letters from them. When I checked my credit report, every one of them had been charged off by the original creditor. The way I look at it, the original creditor has made money selling the paper AND has written off the debt on their taxes, so win win for them. I get nothing by paying off the collection agency. My accountant advised not to pay them.

  • I have learned so much from Mike in regards to cleaning up my credit. My score has gone up 41 points in the last 13 months by reading his terrific steps on how to increase your credit score. I purchased the Credit Solution Program and followed his steps to the letter and my score continued to rise.

    Thanks Mike for everything.

    Larry Marshall

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