Debt settlement is a way to address debt by negotiating with your creditor to pay less than what you owe. While it can save you hundreds or even thousands of dollars, it can also damage your credit score.
Here's what you need to know about how a settled account impacts your credit history and your chances of securing financing in the future.
What is a settled account?
A settled account is a credit card or loan where a lender agrees to accept less than what the borrower owes. Debt settlement generally occurs only when a borrower is significantly behind on their payments. The debt may have even been sold to a debt collection agency.
The process of debt settlement requires you to stop making payments on the accounts you want to settle. By this point, you've likely already missed some payments so the damage may have already been done to your credit score.
But still, leaving debts unpaid for longer than you already have at this point can have a negative impact on your credit.
The primary reason this process can hurt your credit score is that it indicates that you're not paying the debt as originally agreed. Your payment history is a significant part of your FICO credit score.
Not sure where you fit on the credit score spectrum? Then you should start using a credit monitoring service to track changes to your credit score. Credible can get you set up with a free service today.
How long will a settled account remain on your credit report?
A settled account remains on your credit report for seven years from the date the account was first delinquent. This means that if you missed six months' worth of payments and your debt settlement process took another six months, you can expect the settled account to fall off of your credit reports in six years.
Of course, that doesn't mean your credit will be in the dumps for that entire period. Over time, FICO favors new positive information over old negative information — this shows that you're developing and using good credit habits.
But in the beginning, your credit score may take a significant hit and it can be difficult to get approved for a loan or a credit card without a creditworthy cosigner.
Throughout the process, check your credit score with Credible to get an idea of where you stand and how your decision to settle impacts your credit file.
Ways to boost your credit after having a settled account
If you've recently settled an account with a creditor or you're in the process right now, it can take some time for your credit score to rebound. However, there are some key steps you can take to be more effective in the credit rebuilding process:
- Check your credit score regularly: Keeping tabs on your credit score will not only help you track your progress but also show you how your new positive behaviors are impacting your credit score.
- Review your credit reports for errors: It doesn't happen often but it's possible for your credit reports to have inaccurate or even fraudulent information on them. Get a copy of each credit report from AnnualCreditReport.com and read through them to make sure nothing is amiss. If you find something you don't recognize, you can dispute the information with the credit reporting agencies.
- Pay your bills on time, every time: You may have had trouble keeping up with payments in the past. But going forward, make it a priority to pay all your bills on time and in full. This will help you establish a positive payment history and also keep your credit card balances low, which is another key factor in your FICO score. If you lost all of your credit card accounts because of the settlement, consider opening a secured credit card and start making timely payments.
- Request authorized user status: If you have a loved one with good credit, consider asking them to add you as an authorized user on their account. When this happens, the entire history of the account will be added to your credit reports, which can boost your credit score instantly.
It's also important to practice other good credit habits over time, such as keeping the balance on your credit card accounts low and avoiding credit unless you need it. This process can take time but the effort is worth it.
With a credit monitoring service, you can get instant alerts on late payments, fraudulent activities, credit score changes and more. Check out some of Credible's partners here.
The bottom line
Debt settlement can be a great way to get out from under debt you can't afford. But it's important to understand the consequences, especially in regards to your credit history. That's not to say settlement isn't worth it — if you're already considerably behind on payments, settling may not hurt your score that much more.
Plus, getting rid of debt you can't afford can make it easier to practice good credit habits going forward.
If you're concerned about credit score impacts when paying off outstanding debt, you can use a tool like Credible to check your credit and monitor for identity theft.