Does debt settlement hurt your credit score?

Question

Does debt settlement hurt your credit score?

Answer 1

Hi,

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Answer 2

It depends on how the creditor reports the account to the credit bureaus.

If they report it as "settled" then that is an inherently bad notation.

You can negotiate with your creditor to pay them in exchange for them reporting a positive tradeline or deleting the account entirely from your reports.

Answer 3

Hi Miranda!

Your question is an interesting one, and the answer is:

It depends!

Debt settlement could hurt your score, but it can also greatly improve your score.  It all depends on what's going on with your credit right now.

But don't worry, I'm going to give you a simple tool right here to understand how credit works so you can know how debt settlement will affect YOU.

First an example of two clients, James and Anne of Laguna Hills, California, who cut their $55,000.00+ of credit card debt down to just $29,817 (including fees) through debt settlement.  Only 18 months after started their debt settlement program, they were debt free with over $2,100.00 a month in CASH FLOW back in their pockets!

Perhaps even more liberating was checking their credit scores shortly after graduation.  James saw his credit score jumped 74 points while Anne's score jumped 130!!

Can You Imagine...

Going from a 520 score just before starting her debt settlement program to a 650 immediately after graduating?

How could this be?

Let's take a look...

Understanding "how credit works" seems to elude most people.  I think it's that way on purpose, as creditors and the credit reporting agencies make it rather complex and guarded.  

I've found a simple analogy will make it clear for you.

So imagine, if you will, a three legged stool…

And on this stool are these three legs because your credit is really made up of three main factors.  

Each of these factors account for about one-third of your score, while any one of these factors can cripple your credit worthiness (your actual ability to get a loan) regardless of score.

Make sense?

The first leg is your payment history. Your payment history is whether you pay your payments on time, if you have any past due accounts or this kind of thing.

If you have a perfect payment history, then you have something to lose in this area of your credit.  It's as if the first late payment you get KNOCKS your score out of the sky, and each additional late payment has less and less of a negative affect.

So if you have at least one late payment on your credit report (you've fallen more than 30 days behind in recent times), then you've already taken the major hit to your payment history.  

Debt settlement, while causing additional late payments, will not have nearly as severe of an affect on your credit score as it would if you have never missed a payment and maintained a perfect payment history.  

The second leg on the stool is your debt-to-income ratio. This is how much debt service you pay (what you're obligated to pay towards debt) each month verses your net monthly income.  

Add up all payments you must make each month towards debt, including credit cards, medical bills, student loans, mortgage, auto loans, etc.  What's the total?  Divide this amount into your NET (after tax/take home) income.

You want to keep this ratio at or below about one-third (35%), otherwise it becomes a negative factor that hurts your credit score and worthiness.  If your debt-to-income ratio is over half (50%), then you're CRIPPLED and regardless of your credit score you will have great difficulty obtaining any financing for major purchases.  

NOTE: In the past year due to troubles in the mortgage industry, underwriting guidelines have tightened, bringing down the maximum debt-to-credit ratio to 45% in most cases.

Through debt settlement, you eliminate your unsecured debt ALONG WITH the monthly payment obligations you have, thus improving your debt-to-income ratio.

Take your minimum payments on unsecured debt and subtract them out of your debt-to-income ratio to see how big of an improvement debt settlement will have.

The third leg on the stool is your debt-to-credit-limit ratio or “utilization”.  This is how much your current balances are compared to your credit limits.

The ways this works is very interesting. This is probably the least known factor that affects your credit.

Basically, each account you have has a credit limit and a current balance. If that current balance is less than 50% of your credit limit, that’s a positive factor.

Now, if you have an account that’s over 50% utilized with a balance is over 50% of the limit, then that hurts your credit, becoming more severely negative if it gets over 75% of the limit. If your balance gets to the limit, or over the limit, then this is a crippling factor.

Again, you can have a perfect payment history, always making your payments on time or early, but if you’ve got a maxed-out or over the limit account you're stuck.

Through debt settlement your account balances are paid to a zero balance, wiping out any over-utilization and improving this area of your credit.

To make it simple for yourself, look at each of these three legs... And determine which are GOOD vs. BAD for you now.

No one can say exactly how debt settlement will affect your credit score, but after working with thousands of people for over seven years, here's how I see it:

If you have ALL GOOD legs, then your credit will take a hit.  Then the question becomes which is more important, keeping good credit or being debt free?  Credit or cash flow?  

It's up to you.

If you have a perfect payment history and 700+ credit score, and keeping your credit is more important than eliminating your debt and freeing up your monthly cash flow ASAP, then avoid debt settlement.

However, if you have one or more "BAD LEGS", then remember that overall, debt settlement will only hurt your payment history (first leg), and not so much if you've already fallen behind in the past, but debt settlement also IMPROVES the second and third legs, optimizing your ratios.

The worse these factors are for you going into debt settlement, the greater debt settlement will improve your credit, especially for the long term.

Credit is indeed important, but remember:

CASH IS KING!

(And Cash Flow Rules.)

Keep in mind the "BIG IDEA":

STOP paying interest and START EARNING interest, ASAP!

This is critically important if you ever want to retire, and makes all the difference between a life of wealth or a life of slavery (seriously).

*** If you are considering debt settlement, be sure to read this Debt Settlement WARNING: http://ezinearticles.com/?Debt-Settlemen...

Hope this helps!