Home > Credit Score > How Does Settling a Debt Affect My Credit Score?

Comments 0 Comments

Outstanding unpaid debts can do big damage to your credit score, so it’s a good idea to try to resolve them as quickly as possible. Creditors and debt collectors may be willing to work out a repayment plan or even settle the debts for less than what you owe. But can paying this lower amount cause extra damage to your credit?

Unfortunately, the answer is yes.

“Generally speaking …. paying in full as soon as possible is the best action to take in terms of … preserving the credit score,” Barry Paperno, a credit expert who blogs at Speaking of Credit, said in an email.

A debt settlement, conversely, could have a negative effect on your credit score.

“The precise impact of a debt settlement on the score will depend on how this specific information is reported to the bureaus as well as on the remaining information on the credit report,” major credit scoring model FICO said in an email. “FICO research on millions of credit files has found that consumers who do not pay off their loans per the original terms of the agreement represent higher risk to lenders, and as such, if the debt settlement is reported in the credit file with an indicator that the account was paid for less than the full amount owed, that can be viewed as a derogatory indicator by the score.”

An Important Caveat

But that’s not to say that settling for less isn’t your best course of action. Failing to make good on your balances could cause a creditor to take further adverse action against you. They might charge off the debt or resell it to a collection agency. And both collectors and creditors could sue and ultimately secure a judgment against you to get repayment for the debt. 

Newer credit scoring models, including FICO 9, ignore paid or settled collections. These scores, however, are yet to be in widespread use, so there’s still a good chance a collection account will do more damage to other versions of your credit score.

And, when it comes to judgments, “the impact … on the FICO Score is primarily driven by their presence as opposed to their status (e.g. paid-in-full vs. settled),” Can Arkali, principal scientist at FICO, said in an email. “So, if the debt can be satisfied in advance of the judgment filing, that could prevent a more adverse impact to score which might arise if an additional judgment is posted to the credit file.”

In other words, “damage control … i.e. paying as much as you can as soon as you can” should be a major consideration for consumers looking to resolve unpaid debts, Paperno said.

Deciding What to Do

In weighing your options, it’s a good idea to ask the creditor or collector in question how they plan to report any settlement they are offering to the three major credit reporting agencies. You can also try asking if they will remove the collection account in exchange for payment.

If you negotiate a deal, obtain written confirmation of your agreement. And, once you have paid, keep an eye on your credit reports to be sure the account is appearing as agreed. (You can do so by pulling your credit reports for free each year at AnnualCreditReport.com; You can also see what effects the resolution may be having on your credit scores by viewing them for free each month on Credit.com.) If you see the debt is being reported inaccurately, you can file a dispute with the credit bureaus. You can go here to learn more about disputing credit report errors.

More on Credit Reports & Credit Scores:

Image: gpointstudio

Comments on articles and responses to those comments are not provided or commissioned by a bank advertiser. Responses have not been reviewed, approved or otherwise endorsed by a bank advertiser. It is not a bank advertiser's responsibility to ensure all posts and/or questions are answered.

Please note that our comments are moderated, so it may take a little time before you see them on the page. Thanks for your patience.

Credit.com receives compensation for the financial products and services advertised on this site if our users apply for and sign up for any of them.

Hello, Reader!

Thanks for checking out Credit.com. We hope you find the site and the journalism we produce useful. We wanted to take some time to tell you a bit about ourselves.

Our People

The Credit.com editorial team is staffed by a team of editors and reporters, each with many years of financial reporting experience. We’ve worked for places like the New York Times, American Banker, Frontline, TheStreet.com, Business Insider, ABC News, NBC News, CNBC and many others. We also employ a few freelancers and more than 50 contributors (these are typically subject matter experts from the worlds of finance, academia, politics, business and elsewhere).

Our Reporting

We take great pains to ensure that the articles, video and graphics you see on Credit.com are thoroughly reported and fact-checked. Each story is read by two separate editors, and we adhere to the highest editorial standards. We’re not perfect, however, and if you see something that you think is wrong, please email us at editorial team [at] credit [dot] com,

The Credit.com editorial team is committed to providing our readers and viewers with sound, well-reported and understandable information designed to inform and empower. We won’t tell you what to do. We will, however, do our best to explain the consequences of various actions, thereby arming you with the information you need to make decisions that are in your best interests. We also write about things relating to money and finance we think are interesting and want to share.

In addition to appearing on Credit.com, our articles are syndicated to dozens of other news sites. We have more than 100 partners, including MSN, ABC News, CBS News, Yahoo, Marketwatch, Scripps, Money Magazine and many others. This network operates similarly to the Associated Press or Reuters, except we focus almost exclusively on issues relating to personal finance. These are not advertorial or paid placements, rather we provide these articles to our partners in most cases for free. These relationships create more awareness of Credit.com in general and they result in more traffic to us as well.

Our Business Model

Credit.com’s journalism is largely supported by an e-commerce business model. Rather than rely on revenue from display ad impressions, Credit.com maintains a financial marketplace separate from its editorial pages. When someone navigates to those pages, and applies for a credit card, for example, Credit.com will get paid what is essentially a finder’s fee if that person ends up getting the card. That doesn’t mean, however, that our editorial decisions are informed by the products available in our marketplace. The editorial team chooses what to write about and how to write about it independently of the decisions and priorities of the business side of the company. In fact, we maintain a strict and important firewall between the editorial and business departments. Our mission as journalists is to serve the reader, not the advertiser. In that sense, we are no different from any other news organization that is supported by ad revenue.

Visitors to Credit.com are also able to register for a free Credit.com account, which gives them access to a tool called The Credit Report Card. This tool provides users with two free credit scores and a breakdown of the information in their Experian credit report, updated twice monthly. Again, this tool is entirely free, and we mention that frequently in our articles, because we think that it’s a good thing for users to have access to data like this. Separate from its educational value, there is also a business angle to the Credit Report Card. Registered users can be matched with products and services for which they are most likely to qualify. In other words, if you register and you find that your credit is less than stellar, Credit.com won’t recommend a high-end platinum credit card that requires an excellent credit score You’d likely get rejected, and that’s no good for you or Credit.com. You’d be no closer to getting a product you need, there’d be a wasted inquiry on your credit report, and Credit.com wouldn’t get paid. These are essentially what are commonly referred to as "targeted ads" in the world of the Internet. Despite all of this, however, even if you never apply for any product, the Credit Report Card will remain free, and none of this will impact how the editorial team reports on credit and credit scores.

Your Stories

Lastly, much of what we do is informed by our own experiences as well as the experiences of our readers. We want to tell your stories if you’re interested in sharing them. Please email us at story ideas [at] credit [dot] com with ideas or visit us on Facebook or Twitter.

Thanks for stopping by.

- The Credit.com Editorial Team