Credit card settlements can often be seen as a lifeline for many individuals grappling with overwhelming debt. However, it’s essential to understand how credit card settlement affects your credit score before making this significant financial decision.
What is Credit Card Debt Settlement?
To ensure a clear understanding, let’s first define what credit card debt settlement is. Essentially, it’s a process where you negotiate with your credit card company to pay a portion of your outstanding balance, typically in a single, lump-sum payment. After agreeing to your settlement offer, the creditor forgives or writes off the remaining amount.
For example, suppose you have a credit card debt of $15,000, but you can only afford to pay $8500. If your credit card company or the collection agency accepts this proposal, you pay the $8500, and they write off the remaining $6500. This is a form of debt forgiveness. Once the settlement is fully processed, the associated credit card account is closed.
Effects of Credit Card Debt Settlement on Your Credit Score
Your credit score is a numerical representation of your creditworthiness. A lower score implies a higher risk to lenders, making them less likely to lend you money. Conversely, a higher score indicates a lower risk, making lenders more likely to extend credit to you.
Because a credit card debt settlement involves writing off a portion of your debt, it inherently means you didn’t fully repay what you borrowed. As a result, your credit score will decrease.
‘Settled’ Debts Vs ‘Unpaid’ Debts
While not paying your credit cards as agreed has a negative impact on your credit score, a debt settlement can, in certain situations, provide a somewhat positive notation on your credit report.
When debts are listed in collections, it typically means that payments have not been made as agreed for at least six months. This gives the debts an ‘unpaid’ notation. However, a debt settlement allows you to pay a portion of what you owe.
After fulfilling a settlement, you can request the creditors to note that the debts have been ‘settled’ rather than unpaid. While this won’t significantly improve your credit score in the short term, it does indicate to future lenders that you made some form of payment, which is better than making no payments and leaving a balance owing.
Duration of Impact from Debt Settlement on Credit Score
The impact duration of a debt settlement on your credit score largely depends on who negotiates the debt settlement with your creditors. If you negotiate the settlement yourself, or you use the services of a for-profit company, the settlement notation will remain on your credit report for six years from the date your payment is processed. During this period, its effect on your score will gradually diminish as you build up other good credit.
However, non-profit credit counselling agencies often have special arrangements with credit bureau companies. They can instruct that the settled debts be removed from your credit report two years from when your payment is processed.
To Settle Credit Card Debt or Not?
Whether or not you should settle your credit card debt depends on several factors, including your financial situation and long-term financial goals. Credit card settlement is just one form of debt relief; several other options and solutions should be considered before deciding that a settlement is right for you.
Before deciding to pursue a specific option, it’s recommended to speak with a credit counselor, review your situation, and determine which option will best help you achieve your financial goals.
Conclusion
Understanding how credit card settlement affects your credit score is critical. It’s not a decision to be taken lightly, and it’s always wise to seek professional advice before making such a significant financial decision.
Remember, settling your debts for less than you owe is not a common way to deal with debt, and there are risks involved. Consider all your options, understand the consequences, and make an informed decision based on your individual circumstances.
