One of the things that people wonder about debt settlement is the way that it can affect credit scores. Debt settlement can have a number of different effects on your credit score, and some can be good in the long term while others will be negative in the short term. The key to understanding how debt settlement affects a credit score is to understand how credit scores work and how credit reporting agencies evaluate debt settlements.
Understanding How Credit Scores Work
In order to appreciate the effects of debt settlement on a credit score, it’s important to understand how credit scores are produced and what the scores themselves mean. Credit scores are an indication of how much of a risk someone is when it comes to offering them credit. This means it’s an estimate of how likely someone is to pay back their debts and how likely it is that they will default A higher credit score means that a person is less risky than someone with a lower credit score. The level of risk of default a lender sees you as having will influence the interest rates that the offer you on credit and financial products like mortgages, auto loans, student loans, and more. As a result, having a lower credit score can result in you paying thousands of dollars more for financing than someone with a better credit score.
Your credit score is comprised of several different factors, each one weighted differently. The factors include the length of your credit history, your record of on time and missed payments, the percentage of your revolving credit that you are using, new credit, and the mix of types of credit you have. Debt settlement can influence many of these factors, influences some of them more than one way.
Debt Settlement’s Effect on Credit Sore
First the bad news, in the beginning, debt settlement will lower your credit score. Your creditor will report that the debt was settled for less than agreed. This shows that you were not able to make your agreed upon payments. As a result, other companies will perceive you as a greater risk of default, and your credit score will be lowered.
Some more bad news is that a debt settlement will remain on your credit report for a number of years, usually 7-10. This means that you’ll be followed by your settlement for a while, and companies and credit reporting agencies will hold it against your score while it is still on your report. As a result, you’ll be unlikely to qualify for the best terms on different credit and financial products.
Now the good news, if you qualify for debt settlement you’ve probably also missed many payments and have taken a number of hits to your credit report. This means that your score will already be rather low by the time that you start debt settlement procedures.
Debt settlement will stop the entry of late or missed payments on your credit report. This can stop the damage that your outstanding debt is already doing to your credit score, and sets the stage for you to start rebuilding your credit history and increasing your score.
Moreover, depending on what kind of debt you’re settling, you can lower the percentage of your revolving credit that is being used, and adjust the mix of your credit so that it is better for your score. Therefore, you will set the basis to begin growing your score even more.
In the end, the best way to understand debt settlement and credit scores is that in the short term, a debt settlement will lower your score. However, settling your debt also lays the groundwork to take steps to start rebuilding your credit history. You might not be able to access the best credit opportunities, but you can still get things like a secured credit card so you can start building up a history of on time payments. Moreover, because you’re saving money on payments every month, you can use that money to help pay down some of your other debts and get yourself into a better financial situation. That will also help your credit score because you can lower the overall amount that you owe, giving companies more faith that you’ll be able to make your payments on time, and thus aren’t as much of a risk for default.