If you’ve made poor credit decisions, experienced a financial disaster, or ran up a large amount of credit card debt in the past, then you might be familiar with debt settlement. There are many third-party companies that can help consumers settle their debt for pennies on the dollar. But, like most things, setting your debts has consequences.
A debt settlement is the process of negotiating a payoff with your creditor for less than the amount you actually owe. For example, if you owe a credit card issuer $10,000 on a Visa or MasterCard and the company agree to accept only $5,000 instead as payment in full for your debt, you’ve just settled the account.
You can settle debts with your credit card company and other lenders on your own. Or, you can hire a firm that specializes in debt settlement to handle the process for you. In addition to the company’s fees, you typically pay the debt settlement company one set payment each month, and they pay your monthly debts for you according to a repayment plan.
Using a debt settlement company allows you to make only one payment, and it may reduce the total annual interest rate that you pay on the debt. Or, you may be able to negotiate debt settlements yourself with your individual lenders.
What is a debt settlement?
With debt settlement, consumers are often able to reduce their overall debt and pay only a portion of what is actually owed to their creditor. When the consumer pays the agreed upon settlement, the lender will typically update the account on the consumer’s credit report to reflect a balance of zero dollars.
However, in addition to the zero balance, a notation is also usually added to your credit report which reads something like “settlement accepted on this account,” “partial payment plan,” or “settled for less than the full amount.”
Debt settlements are considered to be derogatory events by the credit bureaus and the FICO and VantageScore’s scoring systems. Debt settlements have the potential to inflict a large amount of damage to your credit scores, and they remain on your reports for seven years.
Why debt settlements are derogatory
There’s a lot of misinformation floating around the Internet regarding debt settlement. First, it’s important to understand that a settlement indicates a failure by the debtor to live up to their end of the lender/borrower agreement. Your credit score will take a hit by settling an account.
Events leading up to a settlement typically weigh on your credit score too. If you need to settle a debt, you’re most like having trouble paying your bills and debts. You may have missed a payment. You may have paid less than the minimum monthly payment to get by for a little while. Each of these events negatively impacts your credit score, and you lender reports these missed payments each month.
And, if one of your accounts is already in default, and being reported as such, then the account is already having a negative impact on your credit scores. But, settling the debt will cause more damage to your credit report. It might be minor at that point, but it will still impact your credit score nevertheless.