How debt settlement works, how it affects credit scores
Settlement firms vary, so choose carefully; here's how
By Todd Ossenfort
The Credit Guy
The Credit Guy, Todd Ossenfort, is a credit expert and answers readers' questions about credit, counseling and debt issues.
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Editor's note: The information in this article, while accurate at the time of publication in December 2008, is out of date. For more-recent coverage of debt settlement, please see "Do you have what it takes for DIY debt settlement?"
Dear Credit Guy,
I owe $20,000 on my credit cards. I've had some companies tell me they could reduce this amount by as much 60 percent. Can you tell me a good company to deal with? -- Ed
Paying a percentage of what you owe rather than the full amount is called a debt settlement. There are many different companies offering debt settlement services today. Some are more reputable than others. When you settle a debt for less than is owed, your credit history will take a severe beating. If you are already more than 90 days late in making payments on your credit cards -- which I hope you're not -- then going the debt settlement route will probably not cause your credit score to get much worse.
However, if you are current on your accounts now, settling your debt will make your credit history much, much worse. The reason is because a creditor is only willing to settle a debt for less than the full amount owed, when they believe collecting part of the debt is better than collecting nothing at all. When you are current with payments, the creditor has no reason to believe they will not be able to collect the full amount, and they are very unlikely to consider settling your account.
Debt settlement companies generally collect a monthly amount from you that you can afford to pay in addition to an initial enrollment fee. Rather than dispersing your payments to your creditors, they hold on to the payments for at least three to six months, depending on your circumstances. Next, they try and negotiate with your creditors on your behalf to settle the account. Keep in mind, you are making monthly payments to the settlement company, but nothing is being paid to your creditors, and you will still be receiving the collection calls from the people you owe.
Making no payments to your creditors is reported to the credit bureaus, and your credit score will tumble quickly. Once the creditor has agreed to a settlement amount and your account is settled, that will also be reported to the credit bureaus. Although the account will be marked paid, it will be not be marked paid-as-agreed, which is how you want any account that has a negative listing to be resolved.
Potential creditors viewing your report will see by looking at settled accounts on your credit history that you did not make good on your original agreement with your creditors. I don't know of many creditors who are actively seeking customers who don't pay as agreed; especially during the current tight credit market.
Ed, I know it is tempting to get out from under the $20,000 as quickly as possible. You will need to weigh the negative consequences to your credit history against the consequences of trying to pay out what you owe over a longer period of time. Only you can decide which is the best course for you, but I would stay away from debt settlement if at all possible.
Some words of advice if you do choose to settle your debt -- make sure you choose a company that:
- Is accredited by The Association of Settlement Companies (TASC)
- Has certified debt arbitrators
- Has reasonable fees (shop around)
- Has a service guarantee
- Discloses what is included in your debt settlement program, including fees
- Is a member of the Better Business Bureau or area Chamber of Commerce
- Is licensed and bonded in your state, if so required
Take care of your credit!
Todd Ossenfort is the chief operating officer for Pioneer Credit Counseling in Rapid City, S.D. Pioneer Credit Counseling has been a member of the Association of Independent Consumer Credit Counseling Agencies since 1997.
The Credit Guy answers a question about a debt or credit issue from a CreditCards.com reader each week.
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Published: December 1, 2008