How Does Debt Settlement Affect Your Credit Rating?

Debt settlement is a form of negotiating to pay off your debt in one, immediate lump sum that is less than the total amount you still owe. Debt refinancing and debt consolidation often involve some amount of debt settlement. Whenever you modify a loan, the lender ends up making less than they originally anticipated in your loan agreement. As a result, the lender will charge you penalties and will additionally report the activity to the credit bureaus. Your credit will drop significantly for many reasons.

Debt Settlement Occurs on Past-Due Debt

Most people only seek debt settlement when they are overwhelmed with payments. Seeking debt settlement if you can pay off your loans on schedule does not make financial sense because of the negative consequences. The action only makes sense when you cannot pay your financing through the means you originally agreed on. A lender may not even reach an agreement with you if you can pay off the loan through other means. Because debt settlement is usually on past-due debt, your loan has likely already gone to a collection agency or gone into default. When this happens, your credit score will drop tremendously. Even if you are late on a payment, you will have little to no negative credit activity if you can make the payment before it is 30 days past due and before it goes to collections. Once it goes to collections, however, you will see your credit score take a huge hit.

Loan Modification Appears on Credit Record

Lenders do not like to settle a debt for less than they can otherwise get from a borrower. This means they will be sure to penalize you appropriately. One way lenders penalize borrowers for bad performance on a loan is reporting the bad performance to the credit bureaus. Your credit report is more than just a number. When someone checks your credit, that person gets a complete run down of every loan you have ever had and how the loan was either closed or paid off on time. Future lenders, landlords and employers who see you have paid your loans off on schedule will determine you are fiscally responsible. If you have closed multiple loans not according to the terms, your credit score will tell people you are not to be trusted to uphold your end of a loan contract.

Future Lenders Charge More

Future lenders will always consider your credit report as an essential element in the cost of your financing. Even if you are securing a loan with an asset, a lender will still need to look at your credit report to evaluate your past-performance on loans. If you have a bad credit report, the lender will raise the interest rate on your loan. The lender may also build in less favorable terms; these terms will usually assess high penalties if you choose to modify your new loan. You may even find it is hard to get financing after you have settled your debt instead of paying it off on schedule. 


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