How Does Debt Settlement Affect Your Credit Score?

There is an understandable reason why everyone dreads debt. From the embarrassment of being chased by the PRA Group UK or the Moorcroft debt recovery agency, to the possibility of your credit score being dragged down, debt can be a pain in anyone’s butt.

Couple paying off debts

But regardless of this, people still take auto loans, personal loans, use credit cards, and obtain mortgages, don’t they? If they dread debt, why go for products that carry debts then? Some may quip. The reason isn’t farfetched, we all believe in our financial abilities to refund whatever it is we’ve borrowed, and if ever push comes to shove, and we can’t repay, we know there is always a rescue plan: debt management solutions.

Of all the possible debt solution strategies, none is more effective than debt settlement. Now you see why everyone feels at ease embracing various financial products and packages. But do you know that this debt settlement solution can negatively impact your credit score? Yes, it can, and we are just about to find out how.

What is a debt settlement?

Before we discuss how a debt management solution like negotiation affects your credit score, it is important first to understand what debt settlement is. Debt settlement entails using the help of a company like an IVA company to negotiate the terms of your payments with your creditors.

Most people who turn to this option do so because they’ve exhausted all other possible options like debt consolidation and credit counselling – techniques that are known not to affect the credit score in any way – and they don’t want to experience the embarrassing sight of a Penham Excel staff or a Cabot financial representative knocking on their doors.

When you use this strategy to tackle your debt, your debt can be reduced by up to 50% of the original amount depending on the negotiation terms and agreement.

Debt settlement meeting

How does it affect your credit score?

The period before the debt settlement

Before you approach your lender with the mind-set of negotiation, chances are you’ve been unable to meet your minimum payments, which could be purposeful (maybe you are trying to convince your lender that you are not financially stable anymore) or incidental.

No matter what your score was before this period, you should expect it to go down drastically. Credit reports work hand-in-hand with your payment history, so once you begin to default, the adverse effect is felt on your score.

Late payments

Another typical characteristic of a debt settlement requirement is late payments. If you’ve been making minimum payments on your credit cards, loans, and mortgages before now, only to change your pattern incidentally or intentionally, your credit score will suffer the consequences. Even if you’ve spent years building the score, expect it to fall gradually during this period.

Actual settlement

The biggest straw that breaks the camel’s back comes in the form of the actual settlement. The moment you sit across the table to negotiate a settlement with your creditors, expect a negative history on your credit reports. Debt settlements will not only force your creditor to write a negative history about you, but the entire proceedings will not go unnoticed by the credit bureaus who will, in turn, lower your credit score. Consequently, this will portray you in a wrong light if you ever want to obtain external funding from anyone again.

The negative effect of debt settlement will linger on your score for months, if not years, and it may take another year or two for you to drag your score back up.

Paying your debt

So, what is next?

For the next couple of months after the settlement, you do not want to check your score because what you are likely to find there may be so disappointing. So, you shouldn’t torture yourself like that. Just leave it, and continue making consistent payments on other accounts you didn’t include in the settlement program. And make consistent payments into the debt relief program too. With time your score will move back up as you lower your credit card utilization ratio, settle certain accounts, and keep up with your minimum payments.

Conclusively, after a settlement account is closed, you will start to see changes in your credit score. It may take a while, but little by little, it will get back up. So all hope is not lost.