Settling Debts can Hurt your Credit

The good news is that often when you are struggling with debt and falling behind in your payments, you can work out a deal with your creditors whereby in exchange for your paying off a certain amount of the debt immediately in a lump sum, they agree not to pursue you for the remainder and just settle for what they can get.  So if you owe them $1,000, they might be agreeable to settling for $700 if you pay that in full now.  (You can either work out this kind of deal directly with a creditor, or through a third party such as a credit consolidation company.  The former is generally the better option, as you have to pay a fee to do the latter.)

The bad news is you’re accepting a negative hit on your credit score when you do so.

What is reported to the credit bureaus is not that you paid your debt in full, but that the account was closed and an agreement reached to let you out of some of the debt.  So it still shows up as at the end of the day you walked away from a $300 debt, even though it was with the creditor’s acquiescence.

This obviously looks bad to someone considering extending you credit in the future.  They can see that you didn’t pay off one or more of your past debts in full.

And like other hits to your credit, this entry will remain on your credit report for seven years, potentially harming you that many years down the road.

Now it doesn’t necessarily follow that you should never agree to a settlement of this kind.  For it may be the case that you’re really in over your head, and in the absence of this settlement you’ll just fall farther and farther behind, racking up more interest and fees, and doing as much or more damage to your credit rating as you would have with the settlement.  So it’ll depend on your circumstances.

But also, you may want to consider a different kind of arrangement with your creditor.  Instead of letting you out of the remaining $300 if you pay $700 immediately, maybe they could give you some other break or breaks, which may even in the long run save you that same $300 or more.  But more relevant to the point being made here, they would not show up in a negative way on your credit report.

For example, maybe it’s a credit card bill, and they exercised their option to bump your interest rate to 25% or something exorbitant like that when you missed a payment.  Through negotiation, maybe you can get them to agree to drop that to 18% or 15% or 10%.  Maybe they will lower your minimum monthly payment from $30 to $20 if that’s all you can handle at present.  Maybe they will waive or reduce certain fees for late payments or for your having gone over your credit limit.  You’ll still be obligated to ultimately pay the debt off in full, but the terms for doing so will be less disadvantageous to you.

All of these adjustments will help you, but they aren’t things that will show up on your credit report for people considering extending you credit in the future to see.  They don’t put “red flags” on your credit report.