What Are the Impacts of Debt Settlement and Debt Consolidation on Your Credit Score?

           

For people who are carrying too much debt and are having difficulty making their payments, debt consolidation or debt settlement can be viable options. While it is generally known that falling behind in your payments or missing payments will result in damage to your credit rating, many people are unsure how debt consolidation or debt settlement will affect their credit score. To see the ramifications, let's begin by understanding the two processes.

Debt Settlement

Let's say you have three credit cards with a total balance of $18,000. At an average annual percentage rate (APR) of 23%, you must pay a minimum of $525 per month to avoid default. It will take you 411 months (over 34 years!) to pay off your debt, and you will pay $33,844 in interest. If these numbers seem shocking, you can go to any free online credit card debt calculator website and run the numbers for your own credit cards.

There is a better way. Before you contact a debt settlement company, try to settle your debts yourself. To pay off an account, call your credit card provider. Say that you cannot make your payments and that you want to close the account and pay off the balance with a settlement. Say that if the card company won't do this, you will default and they may get nothing. Your credit card provider will make you an offer. Your account will be closed and you will be put on a payment plan. You must stick to your payment plan; if you fall behind, your credit card company will re-instate the penalty interest rate, which will be over 20%. But if you stick to the plan you will save yourself the $33,844 in the example above.

If your account has already gone to a collection agency, you may need to make a lump payment to the collection agency before the credit card company will offer you a settlement.

What effect will settling have on your credit score? Closing your own account is not a negative action. The three credit reporting bureaus (TransUnion, Experian, and Equifax) offer credit management advice on their websites. They recommend that you do not cancel several accounts at the same time. Close one account, make your payments, and check your credit score. They recommend that if possible you keep the oldest account active, because the older the account, the more positive weight it has on your credit score. Close newer accounts first. Also, don't over-consolidate balances onto one card. You are rated according to how much of your available credit you access. If your credit balances are more than 35% of your available limits, your credit score may be negatively affected.

Debt Consolidation

If you need to act quickly because you are facing severe financial difficulties, you may consider a debt consolidation loan or debt management counseling. You may enter into an arrangement whereby you write a check each month to the credit counseling service, and they pay your creditors. The Fair Isaac Corp. (FICO) assures consumers that while a notation may be placed on your credit history, if you pay your debts through a debt consolidation agency or credit-counseling agency your score will not be affected.

What impacts your credit score significantly are late payments of 30 or 60 days, and missed payments. These negative events will appear on your credit history for up to seven years. If you choose to work with a debt counseling service, monitor the service carefully. Unfortunately, many are unscrupulous, and you need to make sure that the payments are being made to your creditors. After all, it's your name on the credit report.