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Will Debt Settlement Destroy Your Credit?

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If you're drowning in debt and having trouble keeping up with monthly payments, it's time to look for another option. Debt settlement is presented as a lifeline for struggling consumers, but it comes with its own set of risks and dangers to your credit rating. Is debt settlement worth it, or does it do more harm than good?

How Does Debt Settlement Work?

Debt settlement is a process in which your debt is negotiated with the credit card company (or other lender) to allow you to repay what you owe more slowly or for a lesser total amount. If you're behind on payments, credit card companies begin to worry that you might declare bankruptcy and default on the loan entirely - a substantial loss for them. If they can receive at least some money from you, they may be willing to settle the debt for less than the full amount and consider the account paid.

Effect That Debt Settlement has on Your Credit

Debt settlement might sound like an appealing option at first - after all, who wouldn't like to pay back less than the amount they actually owe? But this solution can come at a high price to your credit.

When an account has been negotiated by a debt settlement process, credit card companies will mark the account as "settled" rather than "paid in full", and this can dissuade other lenders from doing business with you - at least until you take other actions to improve your credit score.

The potential impact on credit scores varies widely depending on the prior state of the consumer's credit before they sought debt settlement. Customers with otherwise good credit who seek debt settlement because they have fallen on hard times are more likely to take a serious hit to their credit. On the other hand, someone with chronic bad credit who has always had trouble getting approved for a credit card and paying their monthly bills won't see as much of a change in their credit as a result of debt settlement.

The effect on your credit rating will also depend on how the debt settlement company handles negotiations and payments. Some companies will hold all of your payments in escrow and only turn them over to the credit card company once your renegotiated debt is collected in full. This can be good or bad for your credit, depending on whether the credit card company has been informed of this policy (if they don't know that payments are being held, the credit card may continue to add late fees and marks against your credit). Make sure that there is transparency between the debt settlement company and the credit card firm, and that you are kept informed at every stage.

When Credit Card Debt Settlement is a Good Thing

If your credit has been worsening for a long time, and it just isn't possible to keep up with all of your debts and bills, then debt settlement can actually help improve your credit - not immediately, but in the long term. Settling the debts that are weighing you down may put a temporary black mark on your credit rating, but it also enables you to start fresh and begin rebuilding your credit. If your credit is low or middling, it's possible to restore it to a higher score within a few years if you keep up with your bills and don't fall into serious debt again.

It's important to keep track of all the details of your debt settlement arrangements, especially those that relate to your payments. Check your credit rating after a debt settlement agreement to make sure that the event has been noted fairly and accurately on your credit history - nothing's worse than an administrative error that makes your credit look worse than it actually is. If any errors do occur, take steps to correct them as quickly as possible.

Although debt settlement can do short-term damage to your credit, the service can be helpful in the long term for people who need help extricating themselves from a difficult financial situation.