Will Debt Relief Really Tank Your Credit Score?

Debt relief can be a lifeline for individuals drowning in debt. It offers a way to reduce the burden of debt or create a more manageable payment plan. However, the process of debt relief, also known as debt settlement, can be complex and time-consuming. This is why some people opt to hire a debt relief company to handle negotiations with creditors on their behalf.

While debt relief may provide relief from overwhelming debt, it also comes with downsides, such as its impact on credit scores. Many consumers are concerned that debt relief will ruin their credit scores, as a low credit score can affect their ability to secure loans, rental leases, and even impact rates for auto insurance. It ultimately boils down to prioritizing whether tackling overwhelming debt is more urgent than preserving one’s credit score.

According to Ethan Dornhelm, the vice president of FICO Scores and Predictive Analytics at FICO, enrolling in a debt relief program does not directly impact a FICO score. However, the actions recommended by the debt relief company, such as stopping payments to creditors to build leverage for negotiations, can negatively affect the credit score. Not paying creditors as per the original terms, which often happens when a settlement is negotiated, will be reported on the credit report.

Making partial payments or settling for less than the full amount on accounts can be viewed negatively by the FICO scoring model. Any late payments, both before and after enrolling in a debt relief program, can also impact the credit score. Despite the potential negative effects, settling accounts through debt relief is still preferable to having ongoing delinquent accounts.

The impact on credit scores from settling debts can be significant. Rod Griffin, the senior director of consumer education and advocacy at Experian, one of the major credit bureaus, suggests that credit scores are likely to fall into the subprime range after settling debts through debt relief. While debt relief offers a way to address overwhelming debt, individuals must weigh the benefits against the potential impact on their credit scores before proceeding with the process. Subprime credit scores are a common issue faced by many consumers in the United States. The Consumer Financial Protection Bureau defines subprime credit scores as those falling between 580 and 619, while “deep subprime” credit scores are those below 580. These credit scores can make it difficult for individuals to obtain loans, credit cards, or other financial products with favorable terms.

One potential solution for individuals with subprime credit scores is debt relief, but the impact on credit scores can vary depending on individual circumstances. Jeff Richardson, senior vice president at VantageScore, explains that the effect of debt relief on credit scores is different for everyone. Factors such as the amount of debt being settled, how creditors report the settlement, and the current state of one’s credit all play a role in determining the impact on credit scores.

Debt.org reports that individuals with credit scores above 700 could see a decrease of 200 points or more as a result of debt settlement, while those with scores below 700 may experience a drop of 100 points or more. The negative impact on credit scores is typically seen within 30 days of the information being reported to credit bureaus. However, the timing of when credit scores will begin to recover depends on the individual’s credit profile and the actions they take to improve their credit.

While debt relief can help individuals regain control of their finances, it is important to consider the long-term impact on credit scores. Settling debts can lower credit utilization, which is a positive factor in credit scoring models. However, it may take time for credit scores to fully rebound from delinquencies, as payment history is a crucial component of credit scores.

Despite the potential negative impact on credit scores, debt relief can be a beneficial option for individuals facing significant financial hardships. Many individuals seeking debt resolution are already behind on multiple accounts and have credit scores in the mid-500s. In these cases, debt settlement may be a better alternative to bankruptcy.

According to a report commissioned by the American Association for Debt Resolution (AADR) and published by the Harvard Kennedy School, about three-quarters of debt relief customers had at least one account successfully settled between 2011 and 2020. This suggests that debt relief can be an effective tool for individuals struggling with subprime credit scores and overwhelming debt.

In conclusion, while debt relief may have a temporary negative impact on credit scores, it can provide a path to financial stability for individuals facing significant debt burdens. By carefully considering the potential consequences and taking proactive steps to improve credit after debt settlement, individuals can work towards rebuilding their credit over time. When it comes to debt relief options, settling accounts can be a viable solution for many consumers. According to data, the average debt savings on settled accounts is around 50%, even after accounting for fees. While account settlements can have an impact on your credit score, the long-term effects are often less severe than those of bankruptcy.

Dunckel Morse, a financial expert, explains that after completing a debt resolution program, most clients never need the service again and their credit scores eventually recover. This means that while there may be a temporary dip in credit score, it is possible to bounce back from it.

The type of bankruptcy you choose can also play a role in your decision-making process. Chapter 7 bankruptcy, for example, allows for the discharge of most unsecured debts, but you must meet certain income requirements to qualify. On the other hand, Chapter 13 bankruptcy involves a court-approved payment plan that can take several years to complete.

Natalie Jean-Baptiste, a bankruptcy attorney, suggests that for individuals facing collections lawsuits, wage garnishments, or a significant amount of unsecured debt that cannot be paid off within five years, bankruptcy may be the better option. This is especially true for low-income individuals who may not have other means of resolving their debt.

Both Chapter 13 bankruptcy and debt settlement can have a negative impact on your credit report, staying on file for seven to ten years. If protecting your credit is a top priority, exploring alternatives such as debt consolidation or working with a credit counselor may be worth considering.

In conclusion, when weighing your debt relief options, it’s important to consider the long-term implications on your financial health and credit score. Whether you choose debt settlement or bankruptcy, seeking professional advice and exploring all available options is key to finding the best solution for your specific situation.