When you get into debt, it can be an overwhelming experience. You may feel trapped or like you can’t find a way out. You may feel tempted to give up on everything and seek help from your creditors. However, there are ways to settle your debts at a lower cost.
As more and more people file for bankruptcy and enter the world of debt settlement, it’s essential to understand how debt settlement can affect your credit score. In this article, we’ll go over how debt settlement works, what to keep an eye out for, and if another method might be better for you.
What is Debt Settlement?
Debt Settlement is a method for getting out of your outstanding debt obligations by creating a payment plan with creditors to reduce your overall debt. Debt settlement can be effective as a means of preventing you from filing bankruptcy, but as this Credello’s debt guide shows, it’s not the only option available.
While getting a settlement approved from the company you owe money to can be a great way to become debt-free, the consequences to your credit score might warrant looking at other strategies.
Debt Consolidation vs Debt Settlement
Debt consolidation and settlement often get confused as they have the same goal: getting you out of debt. However, the way they each go about reaching that goal is much different.
Debt consolidation
Debt consolidation reduces the number of creditors you owe money to by rolling multiple debts into one loan or credit card. With a debt consolidation loan, you’re able to make one larger payment that tackles your debt instead of multiple smaller payments to different debtors. Debt consolidation also reduces the number of interest rates your debt is subjected to, making it easier to pay your balances off. Consolidating your debts may also help improve your credit score as it can reduce your credit utilization ratio, but this depends on how you’ve consolidated your debt and how that loan agency reports to the credit bureaus.
The downside to debt consolidation is that you may end up paying more interest in the long run, depending on what your original rates were.
Debt settlement
Debt settlement keeps your original number of creditors but lowers your overall debt load. With a debt settlement, you’ll reach out to each company you owe a debt to and negotiate a payment plan that potentially lowers how much you owe or reduces the interest rate.
The best part about debt settlement is that it’s a great way to get out from under a significant amount of debt. However, the worst part is how it affects your credit score and chances of getting credit in the future. Also, your creditors may not approve your settlement request due to your credit score, assets, or income.
How debt settlement affects your credit score
Debt settlement agreements will typically involve a renegotiation of the original terms agreed to when you opened the credit card or loan. By changing these terms, you’ve shown that you’re unable to meet the initial expectations you were legally bound to and cannot handle credit responsibly. You might feel differently or that extenuating circumstances led you here, but unfortunately, those won’t be reflected in your credit score.
Consequently, your lender will close the original agreement by way of modification, and they’ll report this update to the three credit reporting agencies. If you have other lenders, they’ll be alerted to the change and the cause of it, which will make them less willing to take on the risk of offering you new credit lines.
Is debt settlement right for you?
While debt settlement will affect your credit rating, it’s still better than the hit you’ll take due to missed payments or having to file for bankruptcy. Go into it with your eyes open and decide if debt settlement is right for you or if there’s another way you can work with your creditors to become debt-free with minimal impact on your credit score.
