How Debt Settlement Affects Your Credit Rating

Debt settlement is a legal alternative to bankruptcy that can do more harm than good to your credit rating.

How the process works

A debt settlement agency offers consumer credit help in the form of negotiation. This agency will attempt to convince your creditors to settle for a lump sum payment that is a fraction of what you owe. This amount can range from 20% to 75% of you debt. Once the debt settlement agency has come to an agreement with your creditors, you will pay the specified amount and the creditors will forgive the remainder of the debt. Your debt settlement agency will also collect a significant fee, which can be anywhere from 15% to 25% of your total debt or savings.

Direct impact on your credit

Once your debt has been settled, creditors will report that your remaining balance is $0. It is then up to you to use credit responsibly from that point in order to rebuild your credit. All prior delinquencies will remain on your credit report for up to seven years.

The harm that debt settlement can do to your credit rating is related to the process. In order for agencies to successfully negotiate a deal with creditors, your accounts typically need to be several months late. Debt settlement will have a limited impact on your credit rating if you are already several months behind on your bills.

If you have made some payments over the past three months, the agency will instruct you to stop making payments and save for the settlement. This will create a history of unpaid bills on your credit report that will not be removed. You may eventually be able to repair your credit, however, if you have not been significantly late paying your accounts before, this will make your credit rating worse before it gets better.

Possible dangers that can impact your credit rating

Unlike with credit counseling, collection calls will not be discontinued. That means that even though you may inform your creditors that you plan to settle, they are allowed to pursue payment. Should the creditors choose to, they can take you to court and sue you for the due balance. If this occurs, you will be responsible for the full balance or this negative mark with remain on your credit report.

If debt settlement is successful, you may be required to pay taxes on the forgiven debt. The Internal Revenue Service considers debt forgiveness of more than $600 as taxable income. Should you fail to pay taxes on the amount that you were forgiven, the IRS reserves the right to file a tax lien against your property. Tax liens will appear on the Public Records section of your credit report, and this can affect your ability to obtain new credit.



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