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How does settling credit card debt affect credit score?

Settling your credit card debt typically means that you negotiate an agreement to repay a portion of your balance, because you are facing hardships that prevent you from repaying the debt in full or if you cannot pay your outstanding balance for other specific reasons. While this can help you better control your finances by reducing the debt you owe, an official debt settlement may affect your credit score.

What is a debt settlement?

Credit card issuers regularly report your payment history to credit agencies each month. Along with each payment record, credit card issuers will update your account condition, which include:

  • "Open" (an open account with an open balance, in good standing);
  • "Paid" (an account with a zero balance);
  • "Settled" (an account that has been legally paid in full for less than the full balance).

When you work with your creditor to demonstrate hardship (such as loss of job or extended medical leave), they may be willing to develop a settlement agreement. Settlement agreements allow you to pay less than the full balance against the card, but will close the account after that agreed payment has been made.

How debt settlement affects your credit score

Credit scores are generated by the information found in your credit report. When the credit reporting bureaus (TransUnion®, Equifax®, and Experian®) review your credit report, an account with an account condition of "Settled" may be seen as a negative. A settled account may be seen as proof that you were unable to pay your balance in full. New lenders may look into your full credit report to understand how likely you are to repay any balance they lend to you, so a "Settled" account shows that you were unable to completely repay a balance in the past.

For this reason, while a debt settlement can reduce what you owe and prevent you from using the credit card (limiting your credit expenses), you should expect to see a credit score drop when a debt settlement is officially made. This record of your debt settlement will remain on your credit report for seven years, which can also affect your ability to be approved for loans or new credit lines, and could even be seen as a negative when you apply for a rental home.

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