Without a doubt, debt settlement is one of the most popular debt relief options and people often use it when they are struggling with their outstanding debts. It’s one of the most convenient ways to become debt free in a shorter time span. However, it comes with one major downside and that is its impact on your credit score.
Debt settlement can hurt your credit report and your score will take a dip. This damage is unavoidable when you are settling for lower than what you owe. The good news however is that you can recover the damage and rebuild your score with the right measures.
How Does Debt Settlement Work?
If you are new to the whole concept of debt settlement then this surely is the right place to learn about it. In a debt settlement, you negotiate with your creditor on an agreement to repay a portion of your outstanding balance while the rest of it is just written off and forgiven. The idea of reducing your debt seems really appealing but this debt relief option isn’t for everyone under debt.
You need to meet certain criterias to qualify for a debt settlement. Most importantly, you can negotiate with a secured debt and a settlement is just for unsecured debts that have no collateral. Moreover, you need to have a valid and serious financial hardship that explains why you can’t pay the full amount. It can be anything, from a medical emergency to a divorce or just loss of income. If you have all the right reasons that explain why you can’t afford to pay the entire debt amount then yes, there are high chances that your creditor will accept your negotiation.
What Makes A Creditor Accept A Debt Settlement?
One of the most difficult parts of this process is just convincing your creditor to agree to your terms. Remember that your creditor is absolutely under no obligation to settle your debt. It’s just a whole if and but situation here when you are getting into the process. You need to have some great negotiation skills and a good reasoning to bring your lender to your terms. Most people are afraid of the negotiation process and the stress that comes with it which is why they prefer using a third party service to handle the deal.
Hiring a debt relief company to help settle your debts with your creditor is a great move if you are looking for results and can’t afford any rejections. Even though there’s no guarantee that your creditor will respond positively to your debt relief company, it’s still worth a try because a debt settlement company will approach your lender professionally and with complete preparation. So the chances of success here are higher than what you should expect in DIY debt settlement.
Why Does Debt Settlement Hurt Your Credit Score?
As said earlier, you can’t avoid the damage debt settlement will do to your credit score, but you might wonder, why does it happen in the first place? Well, a high credit score is specifically designed to reward the people who have been punctual in their monthly payments and have been showing a financially responsible behavior. Now when you enter a debt settlement, you basically are negating the original credit contract by paying lesser than what you owe. When your account is marked as “settled”, it shows that you were unable to pay your creditor in full and this serves as a warning to other future creditors that lending you money means more risk.
Why Settling An Account Is Still Better Than Not Paying At All
Even with the potential downside, debt settlement is still better than not paying your debt at all. It’s better for your credit report because a settlement can temporarily hurt your score but when you don’t pay the outstanding balance at all and completely ignore it, things can become worse for you.
When you ignore your creditor, he’ll probably turn your debt over to a collection agency or a third party and this is where the trouble begins. Not only will it be marked on your credit report as “in collections” but it will also reduce your score by leaps and bounds. Moreover, collection agencies can sometimes really become relentless especially with their phone calls and emails. In the worst case scenario, they can even sue you, seize your bank accounts and garnish your wages just to get the amount back.
How Long Do Settled Accounts Remain on Your Credit Report?
Just like most of the negative credit report entries, a settled account can stay on your report for up to 7 years. The starting point of those 7 years depends on multiple factors like the status of your account when you entered the agreement.
In case of late payments: If you’ve been delaying your payments, your settled account will expire from your credit report seven years from the original date of delinquency.
In case of no late payments: If you’ve never been late in your repayments then your settled account will expire from your report seven years starting from the date of the settlement.
This entire situation suggests that you should start missing your payments intentionally before applying for a debt settlement as it will help you get rid of your settlement entry on your credit report faster.
Another important factor to consider is that if you are trying to settle your debt with an account that has a good standing then there are high chances that your creditor will reject your offer. Even if you hire a debt relief company, they will suggest you to stop making your payments at least 5 to 6 months before applying as this will put more pressure on the creditor to just accept the amount you are paying and avoid the risk of not getting any money back at all.
What Happens To Your Credit Score After The Settlement?
Now the most important point is that what exactly will happen to your credit score after you’ve settled? Well, the damage to your score is temporary which means that even though a “Settled” account will stay there on your report for 7 years, you can still take measures to improve your score.
Debt settlement comes with long term benefits and it will eventually help you gain complete financial freedom by opening your doors to different financial opportunities once you are able to rebuild your debt.
The impact of debt settlement will diminish with time but you have to commit to the process and use a responsible approach to achieve your goal. You need to start by;
Making Timely Future Payments: One of the most important factors that impact your credit score is your payment history. Whether it’s a bill or a loan, you are supposed to make timely payments and ensure that nothing goes marked as “missed” or “delayed”. After a debt settlement, you can’t just afford to damage your credit score even more which is why you should start making a great payment history right away.
Avoid Any More Debts: Once you’ve settled your debt, it’s best to avoid taking any more loans especially for the next 10 years. A new loan means more damage to your credit score and more stress.
Keeping Your Credit Utilization Ratio Low: Make sure to use just 30% of your credit limit. You need to keep this ratio as low as you can to improve your credit score. If you are maxing out on your credit limit, it will wreak havoc on your credit report.
The Final Word
A debt settlement negotiation can work wonders for you when you are dealing with a financial crisis. As far as its impact on your credit report is concerned, well it has to happen and you can’t really do anything to stop it. However, you can always rebuild your credit history, increase your score and lead a sounder financial future by just taking informed financial decisions.
FAQs
Q1. How Long Will It Take To Go From 400 To 700 Credit Score?
There’s no guaranteed timeline to tell how long it will take for you to increase your score from 400 to 700 but yes, if you take the right measures, it will take you a few years. It all depends on what marks are dragging down your score and the steps you are taking to improve it.
Q2.Can You Remove Debt From A Credit Report?
Even after settling your debt with your creditor or paying a collections account, it will stay on your credit report for 7 years. However, you can always dispute any accounts that are inaccurate. You can even convince your collectors to remove your account once you’ve paid them.
Q3. Is 650 A Good Credit Score?
The highest range for a FICO score starts at around 670 which means that a 650 score isn’t too bad but it’s not as good as it should be too. To avail financial rewards, you need to have a score above 670.
Seeking help in rebuilding your credit score after it has taken a hit? Try Mountains Debt Relief for quicker, more efficient and the best results.