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Does Settling Credit Card Debt Hurt Your Credit Score?

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Reader Dan told me a story of his friend who was considering settling an outstanding credit card debt but wasn’t sure of the credit score implications:
(Dan): my friend owes like $1100 on a credit card, and he had the balance for like two years and didn’t pay a dime, because he felt he was being taken advantage of
(Dan): well, he went to lease a car last weekend and found out the importance of credit
(Dan): he had bad credit and his new wife basically had none
(Dan): I told him step one would be to clear his balance
(Dan): he called just now, and he mentioned (in IM) something about them offering to settle for like, $700?
(Dan): does settling affect your credit score?

There are a few things going on here at once but in general, settling a debt will improve your credit score. It sounds counter-intuitive but it’ll make sense in a few sentences.

In order for a creditor to even consider a debt settlement, you have to be behind on payments for them to believe you won’t pay at all. This is actually a tactic used by debt settlement companies. When the creditor doesn’t think you’ll pay, they sell it for pennies on the dollar to a collector. If you can pay tens of pennies on the dollar, they’ll take that as the next best thing to paying in full.

The problem is that when you fall behind, your credit will be hammered mercilessly. If the creditor sends it to collections, your credit will sink. The reason your score can go up if you settle is that the account will go from “delinquent” to “paid, settled for less than amount owed,” which is an improvement. It’s worse than “account paid in full” but it’s better than “delinquent.”

Debt settlement experts often recommend that you send a “pay for delete” letter, which is basically an agreement that they will delete the account (and the record of it on your report) in return for paying the amount due. They also recommend that you pay less than 50% (anywhere from 35-50%) of the amount due.

Whether or not that’ll help Dan’s friend get the lease is another issue, having a two year old delinquent account can’t be good and moving it into the “paid, settled” category probably won’t help him too much in the short term.

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17 Responses to “Does Settling Credit Card Debt Hurt Your Credit Score?”

  1. The 35% to 50% recommendation is generally for 3rd party, unaffiliated collections accounts. Trying to settle for this level with the original creditor is very difficult unless you’re in a dire situation or you’re in a recovery situation (the debt was written off and you’re contacting them well after the fact).

    At any rate, “didn’t pay a dime, because he felt he was being taken advantage of” certainly won’t play well with the creditor, the reporting agencies, or future creditors – even if it was at least, in part, accurate.

    Bigger question, leasing a new car? How about buying a used one with cash?

  2. Joe says:

    From what I’ve heard, settling can hurt your credit, unless your account is already in collections. Then, as you said, paying a partial amount is better than still being delinquent.

    • Jo says:

      This is correct. Please be VERY CAREFUL of settling an old debt. I had an old debt for a HELOC with my Ex (I cosigned but never owned the property nor was my name on it..we were divorced). He defaulted and it has been 6 years. Finally we agreed on a settlement with the company who has now reported it paid in full for less than the full amount. We thought that was the end of it.

      However Experian (and only Experian) is reporting it as derogatory paid in full. It was always reported on Experian as a derogatory write off. Somehow paying this off (we lost jobs and had to move to get new ones..and struggled long and hard to offer this settlement which was still thousands of dollars!) dropped my FICO credit score by 84 points! So all the work over the last 6 years (24 items total including car loan, credit cards, student loan) with not even one late payment and this ONE creditor’s one action just deleted all that work.

      To me it’s not worth it at all. Complete and utter misery for actually doing what was the right thing – paying something off! We asked had we paid in full would that matter and Experian said not one bit. So it’s not the amount. Thankfully they say it is scheduled to go off my credit April 2013. That day cannot come soon enough for me!

  3. billsnider says:

    I think people worry to much about their credit scores.

    If you owe money, pay it.

    Bill Snider

    • It really is that simple, isn’t it?! Well said.

    • Shirley says:

      I certainly agree with paying the debts that you incur. However it is possible (though probably not often) to accrue debts through no fault of your own.

      My brother had a financial manager who embezzeled funds intended for mortgage payments. The man is now in prison, but that didn’t wipe out the debt. He ended up making settlement payments to several mortgage companies rather than claiming bankruptcy.

  4. Alan says:

    I gotta ask this question…how did he think he was getting taken advantage of??? Also…why on earth would he just not pay a balance for TWO YEARS!?!?! I mean its only $1100…If you had a lot of CC debt then sure, but $1100 is not that much at all.

    They really should make a finance class mandatory in schools because its obvious this guy had zero clue how credit works at all. Most settlement companies won’t even work with you unless you have $10k+ of cc debt.

    • Jim says:

      I don’t know why he thought “he was taken advantage of” and I didn’t ask, I figured it would get into some deeply wound tale of woe and I wasn’t really prepared to hear it. :)

      • Alan says:

        Maybe he thought he didn’t have to pay interest and that CCs are free??? LOL I can see him looking at his statement going…hey! they charged me this extra money!!!

  5. Queenie says:

    There are thousands of people who have lost thier jobs or have suffered from medical problems that have put them in a sad situation, losing thier homes, cars, and good credit! When we get a credit card that creditor takes out a policy on us (AIG) in the event we default, when the creditor will not even consider making arrangements with these consumers, they charge off the debt report it as a loss at the end of the year and sell the debt to any predator(collection company) who is willing to purchase that debt for pennies on the dollar. Of course we want to pay back the debt to the original creditor, try and do that, the original creditor will not even talk to you. Look up the Fair Debt Collection Act, and see what your rights are as a consumer.If anyone would like a Validation of Debt Letter, email me. Don’t forget there is a statute of Limitations on collecting debt.

    • Help says:

      One of my debts were “charged off” and when I tried to speak with original creditor they said they no longer were responsible for my account, they said they sold it to another collection agency.

      When I called the collection agency, my debt had almost doubled in original amount. I certainly am now pushed behind on my debts becaue of this. I feel like I will never get out of debt.

      To make matters worse, I tried to apply for affodrable housing and when they pulled my credit, they told me what hurt the most was that one of my debts were charged off.

      What do I do now?

  6. leRoy says:

    I cosigned for a “friend” to get an apartment. He worked for a temp agency and they terminated his contract 3 months early. He could not get a job and had to move out of the apartment. Now I am in need of an apartment of my own and this is hendering me. The person says that they are going to pay it off, but 2 years later I am still waiting. It is affecting both our credit, but mine is the one most affected. If you can give any suggestions, I would be much appreciative.

  7. Tim says:

    The impact of settling on your credit score depends on how it is reported to the credit reporting agencies. So it is very important you get something in writing from the creditor about the terms of the settlement. Moreover, settlement for less than what was owed is normally considered a taxable event on the amount forgiven. Getting concrete terms will also prevent the creditor from claiming the forgiven amount in the future or reselling that debt to a collection agency who may try to recapture that amount in the future. If you’ve been alive these past couple of years, you know that this can happen with mortgages.

    If a creditor is going to report the settlement as a charge off on your credit report (AMEX likes to do this when accepting consumer credit counseling proposals), that is a 7.5 year derogatory entry on your credit report. Preference would be a settlement statement that says paid as agreed.

  8. Bobby says:

    My FICA is 691, how would a lender look at that score.? All I have now is a house payment in very good standing and one credit card that I pay off every month if used

  9. V says:

    How can you be certain the creditor will follow through after agreeing to a “pay for delete” request from you?

    V

  10. DRB says:

    ALTHOUGH THE BEST POLICY IS TOO KEEP YOUR CONTRACTUAL AGREEMENT WITH ALL CREDITORS, THERE ARE EXTRAORDINARY SITUATIONS THAT ARISE THAT MAY CAUSE DEFAULT (MEDICAL, JOB LOSS AND DIVORCE ARE THE BIG 3). THEREFORE, WHEN A HARDSHIP EXISTS IT GOES FROM A FULL RECOVERY TOO A PARTIAL RECOVERY. BY ALL MEANS, IF YOUR ABLE TOO PAY THE BALANCE IN ITS ENTIRETY AND WITHIN A REASONABLE AMOUNT OF TIME, DO IT. BUT YOU HAVE TOO REMEMBER THAT THE LONGER YOU WAIT TO RESOLVE YOUR BAD DEBT, THE LONGER IT WILL TAKE TOO GET YOUR PURCHASING POWER BACK! TYPICALLY, WHEN A DEBT IS CHARGED OFF IT WILL REMAIN IN CHARGE OFF STATUS UNTIL IT IS BROUGHT TOO CLOSURE. SO IF YOU LIKE MAKING MONTHLY PAYMENTS FOR YEARS ON END THEN WHY NOT TALK TOO MOM AND DAD ABOUT THIS SO YOU CAN IMPROVE YOUR CREDIT SCORE NOW INSTEAD OF 1-4 YEARS DOWN THE ROAD. FOR EXAMPLE, IF IT TAKES YOU 1 YEAR TO PAYOUT THE BALANCE OR SETTLEMENT AND ANOTHER 5 YEARS TOO NOT BE COUNTED AGAINST YOUR CREDIT SCORE, THEN I THINK THE MATH IS PRETTY SIMPLE. HE SHOULD NOT HAVE WAITED TO RESOLVE FOR TWO YEARS. AS FAR AS A TAXABLE EVENT, ARE YOU SOLVENT OR INSOVENT? THIS WILL HELP YOU DETERMINE IF TAXES ARE DUE OR NOT BUT I WOULD RECOMMEND A PROFESSIONAL. ALSO, YOU MENTION THE REPORTING OF THE DEBT AS IT APPEARS ON THE CREDIT REPORT. THE CREDITOR OR COLLECTION AGENCY WILL REPORT YOUR ACTIONS IN TERMS OF HOW YOU PAY IT, THEREFORE, THIS SOUNDS MORE LIKE WISHFUL THINKING. AGAIN, ALWAYS BETTER FOR AN INDIVIDUAL TO BRING CLOSURE TO UNRESOLED DEBTS IN THE SHORT-TERM. HAVE A WONDERFUL DAY!!!!!!!


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