How to settle debt & remove it from your credit report

Settling debt is essentially coming to an agreement with your creditors to pay back part of what you owe and be forgiven for the rest. If you’re at the stage of considering settling debt, then you’ve already missed several payments, probably months worth, which takes a toll on your credit. So how can you settle debt and minimize the damage to your credit report?

If you have unpaid debt, then your credit score has already been affected. According to FICO, 30% of your credit score is based on the amount you owe on existing accounts. Late payments get reported to credit bureaus by lenders and then the delinquency is reflected in the credit score. Under the Fair Credit Reporting Act, a consumer reporting agency can’t report negative information about your credit that’s more than seven years old or bankruptcies that are more than 10 years old. Seven years may still seem too long to wait, and in some cases, you may be able to remove settled accounts sooner.

Settling your debt

So why would a lender agree to settle with you for less money than you owe? In most cases, they’d rather get some of their money back than none. They also know bankruptcy is a possibility for some people, in which case they might not get anything. It’s also costly for them to collect on your debt, especially if they decide to sue you to pay.

Some people work with debt settlement companies to handle settling debts with creditors or collectors. But you can contact credit card companies, other lenders or debt collectors on your own and set up a payment plan directly. This isn’t the easiest process. There are nuances to calculating a settlement that is both attractive to the lender and affordable for you.

Related article: How to negotiate credit card debt settlement by yourself

How to avoid being sued by a creditor

Your risk of being sued by a creditor increases after the six-month mark (180 days) of nonpayment. That’s when many creditors charge off an account, meaning, they write off a debt as uncollectible and report it as a charge-off to the credit bureaus. However, you’ll still be expected to pay it. The six-month mark is often also the point when your creditor might typically hand your debt off to a third-party collection agency or sell it to a debt buyer.

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

To avoid a lawsuit, try to settle your debts before a charge-off occurs. Call the creditor or the debt collector and see if you can negotiate a settlement. If you have more than one debt, try to target one or two accounts to settle first, prioritizing those that are most likely to sue you. 

How to deal with a debt collector

If you’re dealing with a debt collector, make sure you fully understand the debt. You need to know who you owe, how much you owe and how old the debt is. Then come up with a realistic repayment or settlement plan. 

Finally comes the negotiation phase. If your debt has been sold to a third-party debt collector, you’ll have to contact the new debt owner, or the collection agency they’re using, in order to resolve the debt. Be clear about your financial situation. If they know you can’t afford to pay much, that could make them more willing to accept a lower settlement offer. Before you send them any money, get your agreement in writing.

How debt settlement affects your credit score and credit report

When you don’t pay an account in full, it will hurt your credit score, even if you pay some of what you owe. So don’t expect your credit score to immediately improve after you settle a debt. Typically, though, settling a debt is considered better than not paying it at all.

Paying off a collection account also doesn’t remove it from your credit report. The now paid collection item stays on your report for seven years from the time your account becomes delinquent. This is called the “original delinquency date,” which is the date of your first late payment in a series. Here’s more about how to calculate when an account will be removed from your credit report.

The more time that goes by, though, the less negative weight that settlement carries.

If you’re working through a debt settlement company, they may advise you to stop making regular payments on debt so that you can make a lump sum settlement to a creditor. That can be risky for your credit score, because your late payments will be recorded on your credit report and your score will take a hit. It’s better to have one delinquent account than several, so try not to fall behind on your other bills.

Consider asking for “pay for delete”

As part of your debt settlement negotiation, you may be able to get the creditor or debt collector to agree to report your account as paid in full or have them request to have it deleted from your report. You can suggest this in exchange for paying some of your debt or upping the amount you’re offering to pay. This is not all that likely to work with credit card banks and other lenders, but can be effective with medical and utility collections, and is also now part of the credit reporting policies at three of the largest debt buyers in the nation: Midland Credit Management (MCM), Portfolio Recovery Associates (PRA) and Cavalry Portfolio. You can learn more about each of these companies’ pay for delete policies here. 

Related article: How to negotiate medical bills and avoid medical bankruptcy

How long does it take to rebuild credit after debt settlement?

Your overall credit history will play a role in how fast your credit bounces back after settling a debt. If you otherwise have a solid credit history and have successfully paid off loans or are in good standing with other lending institutions, you could rebuild your credit more quickly than if you have a larger history of late payments, for example.

The further in the past your debt settlement, the better your credit report will look. Still, there are some things you can do to help your credit score improve more quickly over time by focusing on establishing a solid credit repayment pattern:

1. Pay your bills on time. 

This might be the single most important factor to help build up your score, especially if you have a mortgage or car loan you’re current on, or a credit card account in good standing. Paying your bills on time applies to all bills, including rent, utilities, even your internet or phone bill. And if you’re behind on any bills, get them current as soon as possible.

2. Keep your balances low on revolving credit such as credit cards.

How much of your available credit you actually use is called your credit utilization ratio, and it makes up 30% of your credit score. For example, if you have a credit card with a $12,000 line of credit and you’ve charged $9,000 in purchases recently, that means your credit utilization on that one card is 75%. That kind of ratio is going to have a negative impact on your credit scores, because, according to Experian, it can be seen as a “flag to potential lenders or creditors that you’re having trouble managing your finances.” Experts generally agree that it’s best to keep your credit utilization below 30% if at all possible.

Keep in mind however, that if you pay your balances in full each month — meaning, you aren’t paying interest charges — your credit utilization will remain low no matter how much you borrow month to month.

3. Don’t close credit card accounts, even if you don’t use them.

While it’s often not a good idea to open any new credit accounts while you’re working to improve your credit, keeping existing accounts open can help improve your credit utilization ratio, because you have more credit available to you than you’re actually using.

4. Become an authorized user.

You may want to consider talking to a close friend or family member about the possibility of adding you as an authorized user to one of their longer established credit cards. This can help you gain some positive credit history that you lost. But you may not want to do that until all your settlements are complete.

Related article: Can being an authorized user on someone else’s credit card help build your credit?

How long it takes to rebuild your credit after debt settlement depends on a number of factors. There’s no quick fix, but settling your debts won’t hurt your credit nearly as much as not paying them at all — with the added bonus of lifting the weight of the debt-related stress you’ve likely been experiencing.