Are two debt settlements worse for your credit score than one?

Debt settlements and charge-offs kill your score, and they can hurt you in other ways

Keeping Score with Steve Bucci

Steve Bucci has been helping people decode and master personal finance issues for more than 20 years. He is the author of “Credit Management Kit For Dummies,” “Credit Repair Kit For Dummies,” “Barnes and Noble Debt Management,” co-author of “Managing Your Money All-In-One For Dummies” and “Debt Repair Kit For Dummies” (Australia). Steve is an experienced expert witness in identity theft, credit scoring and debt related cases. He has been a presenter at the FICO InterACT Global Conference, the Federal Reserve and the International Credit Symposium at Cambridge University in the UK.

Ask Steve a question, or see if your question has already been answered in the Keeping Score answer archive.

Are two debt settlements worse for your credit score than one? 

Settling a charged-off debt for less than what you originally owed is a score killer, and doing it twice just makes it worse. But these financial missteps can also hurt you with regard to your taxes and future employment opportunities.

Expert Q&A

Check out all the answers from our credit card experts.

Dear Keeping Score,

I recently started working after several months of being unemployed. My $10,000 Citi credit card debt is now being handled by a collection agency. They say it's in pre-charge-off status, and still owned by Citibank. 

They offered to settle for a 50 percent lump sum – which sounds like an attractive option to me, even with the damage to my credit report. Of course, I'd get the offer in writing first.

So, that got me thinking: If my credit report will be damaged anyway, maybe I should wait for my $12,000 Bank of America debt to go to collections, and settle that, too? Is there much difference between one settlement and two? Am I overlooking anything? (I can use debit cards for purchases, and I've never financed cars.) -John

Dear John,

While not exactly a free lunch, the possibility of paying only half of your bill is tempting indeed. But you will pay for the other half in different ways over the next few years if you go the settlement route. The major concerns I have relate to your credit report, credit score, future employment opportunities and taxes. Let’s look at each one:

Credit report

The negative reporting of the charge-offs will show on your credit report for seven years from the date you first became delinquent and never brought the account to a current status again. If you are in a pre-charge-off status you are probably around 120 days past due. So the negative item will be on your report for an additional six years and eight months. That will be well into 2025.  

I want you to consider all the times in the last six years and eight months when your credit report was reviewed. Since March 2012 you may have looked for an apartment, bought a home, bought or leased a car, applied for a new job, opened a bank account, applied for a credit card or line of credit or financed a furniture purchase. Do any of these sound familiar?  

Charge-offs and settlements can complicate all of these activities and more. Looking forward, do you intend to do any of these things between now and 2025?  Your credit score will recover long before these items fall off your credit report, but anyone who pulls your report will see them. The financial effect will be sort of like dating with one or two big pimples on your nose. They’ll count for less over time but they’ll still be visible. So you’ll still get dates, but maybe not the ones you want.

Tip

Tip: Can you qualify for a construction loan after settling credit card debt? Construction loans generally have more stringent requirements than a standard mortgage, so you may need time and new forms of credit to rebuild your credit score. 

Credit score 

Yes, there is a difference between one and two charge-offs. Charge-offs fall under the payment history credit scoring factor, which makes up 35 percent of your score. Some other factors that are included under payment history are how many accounts are delinquent, the passage of time since the delinquency and how long the payment was overdue. 

If the Citi account is your only item in default, then a charge-off will have a major impact. Depending on how good your score is, you could be looking at losing more than 100 points for the better part of a year for just one charge-off default. A second charge-off will only make matters worse. 

Also, be aware that the major negative impact on your score could last for longer than a year, although it will diminish slowly after several months have passed. Settling the debt can make your score drop even further. 

However, there may be a different type of damage from the settlement, which I will detail in the next section.

Future employment opportunities

You’ve been unemployed and know how little fun that is. You have a new job and my guess is that for the next three to six months you’ll be on probation and not secure in your new position. (Secure is a relative term today.)

So, consider the odds that you’ll be back in the job market in the next seven years. Consider also if you think you’d like to get a promotion in that time period. Well, a charge-off and settlement will be on your credit report for the next seven years – the same credit report employers review in hiring and promotion decision making. 

The charge-off and settlement could raise questions about your character, judgment and commitment to keeping promises, placing you at a potential disadvantage among other candidates and increasing the chances an employer will just pass on to the next candidate rather than ask you what happened.

See related: How soon will my credit score recover from a collection item? 

Taxes 

There are tax implications with a settlement. Forgiven debt amounts of at least $600 less than the original balance are reported to the IRS as taxable income, which means you may be responsible for paying income taxes on $11,000 if you decide to settle both accounts. That is enough to potentially move you into a higher tax bracket, making your tax bill that much higher. 

This is something you should take into consideration as you calculate how much this is really going to cost you. You are also assuming that Bank of America will be willing to settle for 50 percent of your balance, and that may not be the case. The bank could just take you to court and garnish your new wages for the full $12,000 plus interest, late fees and legal costs. 

Try a debt management plan if you have enough cash

Before you jump off what I consider to be a very high cliff, remember you have a choice here.

You have two cards with a total outstanding balance of $22,000. Since you seem to be considering the 50 percent lump sum offer, you must have $5,000 available right now in order to accept it. If you have another $6,000 available to settle the second debt, you have $11,000 available to you right now. You can certainly just set up a payment plan that will repay your debts in full over time instead of choosing a much more damaging charge-off and settlement.

However, if you decide to go ahead with settlement, I would suggest you take a do-it-yourself approach. There is no need to work with a debt settlement firm and pay their fees. You will need to establish a paper trail so that you can get every detail in writing before you make any payments. 

And you are going to want to be very careful to do everything you can to walk the straight and narrow when it comes to your finances for the foreseeable future. This means paying your bills on time and only taking out new credit when you absolutely must.

I know you are not concerned right now, but the time will likely come when your credit report will make a difference in some future life decision and the steps you take now and in the next few years will determine how much your credit decisions will cost you.

Remember to keep track of your score!


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Updated: 12-15-2018