Credit Card Debt Settlement - How It Affects Your Credit Score

Reader Question: If I do a settlement on a credit card, how will it affect my credit score?

Settling the debt on your credit card will hurt your credit score. But missing payments and having them sent to collection will also hurt your score. So then it becomes a question of which option best resolves the problem for you.

Let me explain some terminology here, for the benefit of other readers. Credit card debt settlement is a technique used by people who are up to their ears in credit card debt and see no way of paying it off. Basically, you are negotiating with your creditor (in this case the card company) to pay off as much of the debt as you can. For the creditor, this can sometimes be a better option than sending the delinquent account to collection. Even if they accept less than the full balance due, they are getting something out of it ... and getting the bad account off their books at the same time.

Of course, you can bet that the credit card company is going to report the settlement, which means it will show up on your credit reports. And as you know, your score is based on the information contained within your reports, so the credit card debt settlement will hurt your score to some degree.

The next logical question is, "How much will it hurt my score?"

Unfortunately, this is not something I can answer. The effects of a credit card debt settlement vary, based on a number of factors. But I can say that, for many people, a settlement is often the best way to go. You aren't necessarily wiping the slate clean, because the settlement is still going to appear on your credit report. But it is a way to get some form of closure, instead of letting the overdue payments follow you forever.

Keep in mind also that negative information only stays on your credit report for seven years, at least in the case of debt settlements. So if you settle this year, it won't even show up on your credit history seven years from now. In a certain sense, this is better than letting your overdue payments follow and haunt you indefinitely. Additionally, negative events such as a credit card debt settlement tend to have less of an impact on your score over time. So if you can avoid any other problems, your score will gradually "rebound" over time.

If I had to rank the best possible scenarios for people with too much credit card debt (and no way to pay it off) -- in terms of best to worst option -- I would rank them like this:

• Ideal scenario = paying off all of the debt, including fees
• Next-best scenario = settling the debt, taking the credit score hit, and getting on with your life. You could then focus on repairing your score.
• Worst option = Ignoring the problem and waiting until the account gets sent to a collection agency.

In the latter two scenarios above, something is going to be reported to the credit reporting bureaus. So in both the second and third scenario, your score is going to take a hit. But with the "next-best" scenario, you are at least achieving some kind of closure.

Disclaimer: I'm not telling you which option to choose. I'm just sharing my thoughts on the matter. Debt