How does debt settlement affect your credit score?

If you’re considering settling your debt or already in the process, you no doubt want to know how debt settlement will affect your credit score.

The answer depends on a number of factors. Debt settlement will hurt your score, but that might be acceptable to you, especially if you have several delinquent accounts that have already bruised your score. And debt settlement will probably damage your credit score less than a bankruptcy would.

What happens to your credit score while you wait to settle

Some of the damage to your credit score could come while you’re in the process of trying to settle your debt. If you hire a debt settlement company to handle negotiations with your creditors, the company might ask you to stop paying your creditors and put that money in an account to be used for a lump-sum payment. But in the meantime, interest and late fees pile up and those late payments are reported to the credit bureaus.

If possible, it’s best to settle your debts, or at least some of them, before the lender charges them off. A charge-off occurs after a borrower hasn’t made any minimum payments on an account for about six months. It’s essentially the lender writing off the debt as a loss — but that doesn’t mean you no longer owe the money. If you have multiple accounts to settle, it might be tough to both negotiate a settlement and come up with money to pay it  before a charge-off happens. Instead, you might target just an account or two to pay off first.

Related article: What does it mean to have my unpaid debt charged off?

The longer you go without paying your bills, the more likely it is that your creditor will sell your debt to a debt collector, which can cause an additional negative item to appear on your credit from the new owner. You also risk being sued and having a judgment brought against you in court.

What happens to your credit score after debt settlement

After you’re done settling your debt, your accounts will be closed and marked as settled. Some of these accounts may have already been closed by the lender in a charge-off.

Settled accounts stay on your credit report for up to seven years from the time they were charged off. Debt buyers reporting their own negative entry on your credit should be removed at the same time that your original creditor is taken off.

Settled accounts are somewhat negative on your credit because you didn’t pay off the account in full or as originally promised. However, the older these debts get, the less weight they carry.

Related article: 5 steps to rebuild credit after debt settlement

If the accounts you are settling are older, they also could hurt your credit score. That’s because 15% of your FICO score is based on the length of your credit history, including the age of your oldest account. On the plus side, closing these accounts will lower the amount of your balances, which makes up 30 percent of your FICO score.

The biggest factor in your credit score is your payment history, which accounts for 35%. That’s why missing payments hurts your score so much. But once you start making timely payments again, you’ll start rebuilding your credit. Settling a debt is usually considered better than not paying one at all.

Related article: How to settle debt and remove it from your credit report