How Does Debt Settlement Affect Credit?

Collections and Charge-Offs

The most common forms of debt settlement occur either in collection accounts, where a delinquent account is sold to a collection agency, or charge-off accounts, where the creditor writes off the account as a bad debt. Both collections and charged off accounts adversely affect your credit and your ability to make large purchases such as homes or cars. You may think that paying off debts or settling them for less in either of these circumstances will boost your credit score; however, depending upon the age of the accounts in question, it could hurt more than help.

Negative items on a credit report have a shelf life of seven years (10 years for judgment accounts or bankruptcy filings). Whenever new activity is noted on an account, it resets the "clock" for another seven full years. So settling a six-year-old debt, for example, will reset the reporting clock as if the account were brand new. Something that would have dropped off your credit report in the next year will now haunt you for additional seven years after settlement. In contrast, participating in a restrictive endorsement settlement can make you more creditworthy and delete such items from your credit report.

A restrictive endorsement involves offering to settle the debt for less than what you owe, but requiring the agency to cease reporting the debt to the credit agencies altogether. They are not allowed to report it as a "paid collection" or "settled" on your credit report; they are asked to delete the file from your credit report completely, as if it never existed. This can lead to tremendous jumps forward in your credit score, and can potentially "erase" many negative items on your credit history. For more information on a restrictive endorsement, it is wise to consult a credit-repair attorney and pay her to settle your debts in this manner so that you are protected by law when making settlement offers or arrangements.

Overall, settling debt help eliminate annoying collection calls and letters. However, settling debts improperly can leave your credit scarred for many years. When making changes or improvements to your credit report, consult a professional credit-repair attorney rather than a credit-advocacy program. While it might be more expensive up front, it's well worth the investment in the long run.

To find a qualified credit-repair attorney, interview at least three different firms specializing in the field. Ask them about their credit-repair strategy for settling or disputing your debt. Ask to see success rates of prior cases. Good credit-repair attorneys have lots of satisfied clients, so if yours has fewer than five positive references, consider moving on to the next attorney on your list.