If you’ve been researching debt settlement, you may have read about its “devastating” effects on your credit score. The potential damage to your credit score may cause you to rethink using debt settlement as a debt solution, but all is not lost. Let’s take a look at how debt settlement actually does hurt your credit score.
Credit Score Calculation
Your credit score is based on five key types of information:
- How timely you pay your bills
- How much debt you have
- How long you’ve had credit
- The types of credit you have
- The number of recent credit applications you’ve made
When you settle a debt, it affects the part of your credit score that considers timely debt payments.
Two Effects on Your Credit Score
In the debt settlement process, your credit score will take two separate hits. First, your credit score will likely fall because of the missed payments that are likely required to make settlement happen. Credit card companies likely won’t take a settlement offer on an account that’s current on payments. So you’ll probably have to fall behind on your payments by at least 90 days before you can make a settlement offer that would be accepted by the creditor. Those 90-day missed payments will likely cause your credit score to drop.
Then, when you actually settle your debt, the settlement will go on your credit report and that will likely also negatively affect your credit score.
The Higher Your Score the More Points You’ll Lose
Not long ago, FICO, the company who creates the FICO score, released information that tells us roughly how many points a person stands to lose if they settled a debt. There were two different credit profiles. A person with a credit score of 680 would lose 45 to 65 points from a debt settlement. Their credit score would drop to a 615 to 635. Of course, this does not take into account the effect of the missed payments on one’s credit score.
The second profile was of a person who had a 780 credit score. That person would lose between 105 and 125 points from debt settlement bringing their credit score to a 655 to 675. Again, this does not take into account the effect of the missed payments on one’s credit score.
For comparison, the person with a 680 credit score would lose 130 to 150 points if they filed bankruptcy and the person with a 780 would lose 220 to 240 points by filing bankruptcy. Your actual credit score loss could be greater depending on the information in your credit report.
Credit Score Can Be Recovered
The credit score drop that happens during and after debt settlement is only temporary. Your credit score moves up and down based on the information in your credit report. Not only that, your credit score is most affected by things that have recently happened. So as your debt settlement gets older it will affect your credit score less. In addition, you can add positive information to your credit report to try to bring your credit score back up to it’s pre-debt settlement level.