One major drawback of a debt settlement is that your credit score gets dinged. It’s not just with debt settlement, in fact, even if you choose any other debt relief option, you’ll face similar consequences. The fact that it damages your credit report is the reason why people use it when it’s their last resort and the only other alternative they have is bankruptcy.
A debt settlement affects your credit but at the same time it’ll reduce your debt which is something you can’t overlook especially if you have a huge outstanding balance to deal with. Settling debt is specifically an option for those who aren’t able to pay off their debt due to some financial emergency. It can be anything, whether you are going through loss of income, a divorce or some medical emergency, you can always try settling your debt with your credit.
Now, speaking of settlement and its consequences, there are certain measures you can always take to at least minimize the credit score drop during the process. Let’s break it all down for you today!
Understanding The Impact Of Debt Settlement On Your Score
For starters, you need to understand the reason why a settled debt reduces your score in the first place. You see, a fair credit score is a sign that the person is financially responsible and pays his bills on time hence he gets to use all the additional financial benefits. On the other hand, someone with a poor score indicates financial issues or irresponsible financial behavior.
Now, when you are settling your debt, you are basically paying less than the original amount that you owe. This just negates and modifies the original credit agreement which is why your credit score suffers a blow. When your account is marked as “Settled”, lenders view this as a negative event and they become hesitant in lending you any further loans especially due to your poor credit score.
Effective Measures That Can Help You Avoid A Credit Score Drop
To ensure that debt settlement causes as little damage to your credit score as possible, here are some effective and useful tips that can really come in handy to you. Starting with;
1-Only Try To Settle Delinquent Accounts
When you are already behind your payments on specific accounts, your credit score is likely already impacted by it. Settling the delinquent accounts won’t do much damage to your score but if you try to settle the current accounts, it can give your score a bigger blow. It’s best to avoid settling any current accounts that are already in a good standing. Just go for the ones that are already affecting your score.
2-Negotiating With Your Creditor
If you really don’t want your credit score to drop during the settlement then it’s best to talk to your creditor about it. During the negotiation, you can put up your concern in front of your creditor and request him to mark your debt as “paid in full” instead of “Settled”. If the creditor agrees and he doesn’t report your debt as “Settled”, this can really save you from a lot of credit score damage. Most of the time, creditors don’t accept such requests but if you have a good relationship with your creditor then there’s no harm in asking.
3-Don’t Delay Any Payments On Other Accounts
While you are settling one debt, make sure that you are keeping your other current accounts in a good standing. In short, you should not miss or delay any other payments of your other active accounts. Timely payments and a low credit utilization ratio are two important factors that can soften the impact of a debt settlement on your credit score.
4-Settling All Of Your Accounts At Once
Instead of settling your accounts one by one and constantly damaging your credit, it’s best that you settle all of them at once. This way, the negative marks will affect your credit score in a single wave and after the damage, you can then start rebuilding your score instead of worrying about settling the other accounts.
5-Document Everything
During a debt settlement, it’s of utmost importance that you get everything about the agreement in writing. Documentation of all important details including the total amount you owe, the settlement percentage decided and a promise that the debt will be marked as “closed” or “paid in full”, you are supposed to have it all written no matter what. When you have evidence, you won’t have to worry about any shocking or unexpected hits to your credit score that you weren’t informed about.
Explaining The Credit Score Drop In Detail
Your credit score will start dropping immediately when you enter into a debt settlement. This usually happens when you stop making your payments on your credit cards. Your “Settled” account will stay on your report for 7 years starting from the first day of your missed payment. However, as the settlement ages, its impact on your credit report will diminish overtime especially if you show responsible financial behavior and make timely payments after the settlement.
The Initial Drop
The initial significant drop you’ll face during a debt settlement is because of the payments that you stopped making. Late or missed payments always impact credit scores negatively and the same is the case here. If you want your creditor to accept your agreement, you have to stop making your payments at least 5 to 6 months before the settlement. This just gives your creditor the impression that you really are unable to afford the debt and a settlement would be the wiser move.
The Impact Starts Diminishing With Time
With the passage of time, when your settlement becomes at least 2 to 3 years old, you’ll see that its impact starts carrying less weight. The negative effect fades away especially if you are using other accounts responsibly.
Duration On Your Report
A settled account will stay on your credit report for 7 years. It starts from the first date of your missed payment regardless of when the debt was actually settled. However, your credit score doesn’t stay the same for those 7 years and it starts improving right from the moment you start making any efforts to rebuild it. The rebounding won’t take a long time and you can easily bring your score back to fair by just demonstrating responsible credit behavior. Just make timely payments, keep your credit utilization ratio low and get a secured credit card or a credit builder card for a quicker credit score rebound.
Overall Verdict
Avoiding credit score drop during debt settlement isn’t as difficult and complex as it sounds. It’s just that you have to follow the steps carefully and ensure that you are settling your delinquent accounts first. It would be a grave mistake to start settling your current accounts that are in a good condition because that’ll just bring your score down to a whole other level. Moreover, as the consequences of debt settlement are temporary, you don’t have much to worry about especially if you have a strong will to improve your credit. It’ll take you just a matter of time to bring your score back with responsible financial and credit behavior.
FAQs
Q1. How Many Points Will My Credit Score Drop If I Settle My Debt?
You might suffer a loss of 100 points in your credit score after a debt settlement. It can be more or less depending on your credit history and the amount of debt you are settling. Such a drop can make it very difficult for the individual to qualify for credit, loans and reasonable interest rates for years.
Q2.What Is A Good Amount To Settle A Debt?
As per research, the average settlement amount is around 50.7% of the total amount you owe. On the other hand, the average amount of debt enrolled is around $45,000 which means that if you are dealing with such figures, you’ll still have to pay a hefty amount to settle your debt.
Q3.Can I Get A Credit Card After Debt Settlement?
Yes, you can get a credit card after debt settlement. It’s just that you’ll have fewer options available with lesser credit limits and higher interest rates. If you wish to get the traditional credit card with reasonable interest then it’s best that before applying for one, you start working on improving your credit score. With a fair score, your chances of securing a credit card improve and you’ll also have access to multiple options of choice.
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