Return to the Home Page
Our editorial team is independent and objective. To help support our review work, and to continue our ability to provide this content for free to our readers, we receive compensation from the companies that advertise on the CreditMashup site. This site does not include all companies or products available within the market.

We also include links to advertisers’ offers in some of our articles; these “affiliate links” may generate income for our site when you click on them. The compensation we receive from advertisers does not influence the recommendations or advice our editorial team provides in our articles or otherwise impact any of the editorial content.

While we work hard to provide accurate and up to date information that we think you will find relevant, CreditMashup does not and cannot guarantee that any information provided is complete and makes no representations or warranties in connection thereto, nor to the accuracy or applicability thereof. Here is a list of our partners who offer products that we have affiliate links for.

Debt settlement can hurt credit scores

Debt settlement can hurt credit scores because having late payments are essential to settlement, creditors are motivated to settle when you have multiple lates
I am debt free sign on green doors.

Debt settlement means a creditor is willing to accept less than the balance due for a debt.

Settling a debt can hurt credit scores because any payment status other than “Paid as Agreed” or Paid in Full” puts your credit history in the risky category.

It’s likely the creditor will report a settled debt as “Settled” or “Paid Settled.” Because you aren’t paying your full balance as agreed, debt settlement can have a negative impact on your credit scores. For example, if your credit card issuer agrees to settle for $1,200 when the debt owed is $3,000 it indicates default, even though you paid a partial amount.

The truth is that debt settlement can hurt your credit score almost as much as a bankruptcy.

How credit card debt settlement works

Settling a debt with creditors, mainly credit card companies, involves making an offer to settle the balance owed for a lesser amount.

Credit card companies will sometimes accept a lesser amount because it may be more cost-efficient then sending an account to a collection agency or pursuing a lawsuit against the customer.

The key to debt settlement is customers must have the entire settlement amount upfront, in one lump sum.

But there’s a downside to debt settlement and here are a few reasons why:

  • When an account is settled for less it indicates a higher level of risk because the account is typically overdue.
  • Debt settlement indicates you did not honor the original terms of the account agreement as well as walked away from purchases you made and debt you incurred.
  • Credit scores may take a dive.
  • A tax liability may be created and you end up owing the IRS.

How many points will credit scores drop

With FICO scores, debt settlement will factor in the calculation of your credit score. The reason being is that consumers who settle the debt for less than owed have typically missed payments.

This means a 30-day, 60-day or worse, a charge-off has been added to credit reports.

But late payments are practically essential to debt settlement because creditors are usually only motivated to settle debts that are at risk of never being paid.

FICO doesn’t reveal exactly how many points will drop from your score if you settle but they have listed a range of points your score will drop.

  • The higher your FICO score, the more debt settlement will hurt.
  • If your FICO score is already low, there will be less of a drop.

In some instances, debt settlement can be just as negative as bankruptcy if your credit score is high. But take this information with a grain of salt. The FICO scoring system is complex and consumer credit profiles respond differently to specific situations.

According to FICO:

  • Consumer with a 680 FICO score can experience a drop in score between 45 to 65 points.
  • Consumer with a 780 FICO score can experience a drop in score between 140 to 160 points.
  • And don’t forget, any delinquencies that led to debt settlement will remain on your credit report for seven years.

How to recover your FICO Scores

Debt settlement will have less of an impact on your credit score the older the information gets and as you add positive information to your credit files and pay other obligations on-time.

Once a settled debt is on your credit report for 48 months, it is no longer used in calculating your credit score. But you still need positive information to help counteract the negative information.

Other issues with debt settlement

It may look favorable for a debt settlement notation to appear on your credit report because you made an effort to pay but a lender may still view you as a high credit risk. Lenders may hold it against you that you did not honor the original contract. 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 credit scores.

Debt settlement can create a tax liability

When a credit card company forgives any amount of a debt, there’s a real possibility of a tax liability unless you qualify for an exception or exclusion. The IRS along with your state government can view the amount you did not pay as “forgiven” or “canceled” debt and consider it income. You can end up owing taxes on that “income.”

Credit scores may suffer with or without debt settlement

When weighing the pros and cons of debt settlement keep in mind your credit scores can still suffer without debt settlement. If you are struggling to pay your bills on-time, have credit cards that are maxed out or can only make the minimum payments your credit scores can suffer.

If you’re in this situation you may want to consider debt settlement just to get a fresh start. Your credit scores will recover naturally over time once your debts are resolved plus settling debt puts an end to interest charges, late fees and collection calls.

But one of the main reasons debt settlement is a “damn if you do – damn if you don’t” situation is that debt settlement even if you make a deal with a collection agency to delete to a collection account from your credit reports as part of a settlement, the negative information reported by the original creditor (i.e. charge-off) will likely will remain on your file.

But there is an advantage to debt settlement in the form of credit utilization. Settling your debt could help mitigate the credit score damage because 30 percent of your FICO score is determined by how much you owe. Bringing down outstanding balances can make a big difference in some consumers’ credit scores.


Explore More

Send Us A Message

Get In Touch

6080 Center Dr, 6th Fl
Los Angeles, CA 90045

© 2024 All Rights Reserved.