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Debt Settlement Vs Debt Consolidation – The Impact on the Credit

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According to figures released by the US Federal Reserve (https://www.cardrates.com), Americans are carrying more than $1 trillion in revolving debt balances in 2018, out of which $830 billion is in credit card balances. For cardholders who have racked up debt far in excess of their repayment capacity, it can mean a torrid time. One sees this even more, in the events of making the due payment, facing calls by debt collectors, or getting sued. Additionally, making payments late or defaulting on the monthly payments results in the credit score being negatively impacted. Consequently, this affects the cardholder’s ability to take on debt in the future on good terms.

The Impact on Credit Scores When You Settle Debt

While the credit score is a numerical representation of your credit report, the actual report carries your full financial profile. This includes the complete history of each loan account, including information on whether you made the scheduled payments. This also includes information on late or missed payments. The extent of the impact depends on several factors. These factors are like current credit condition, reporting systems of creditors, and amount of the debts you want to settle. Moreover, these also include extent of the settlement, whether the cardholder account is now in good standing, and other variables. Also, your credit score may already have taken a beating because of late or missed payments or high credit utilization. Hence, it may call for considering debt settlement.

More the Delinquency less the Credit Score Impact

For creditors to consider debt settlement, you need to put up a show. You need to demonstrate that you are seriously in trouble and are a prime candidate for bankruptcy. This automatically means that creditors are not likely to entertain a settlement request. This is in spite of you paying on time despite facing a financial crunch. Hence, it’s far better to try to settle debts that are seriously past-due. They perhaps may get classified as delinquent and turned over for debt collections. The way the authorities calculate the credit scores, beyond the initial hit, slows down the rate of drop of the score. This is even as the debt becomes more delinquent.

It does not matter whether you settle personally with the card issuer or engage a professional debt settlement company. You should attempt to get the lender to agree to report the debt settlement as “paid-settled.” You must do this instead of making an agreement for “paid as agreed.” This is despite the fact that the impact on the credit score is less. Though, it seems very unlikely that the lender would agree on unless the settlement does not involve much reduction. Still, if you can, you should try to negotiate to have it reported as “paid in full.”. Read up on debt settlement feedback online to find out how lenders usually report debt settlements.

Other Issues to Keep in Mind

You should also bear in mind that if you settle multiple accounts, the impact on the credit score will be more. This is despite your settling for just one. The amount of the balances settled also has a bearing; the impact of settling a smaller debt while maintaining a clean payment record on a card with a larger balance could be minimal. Also, beware of settling any old debt that has already been sent for collections. This is, as the authorities can reflect it as a current collection and reactivate the outstanding in the credit report. It is better to keep current accounts in good standing rather than try to settle older accounts. Your credit report will show a debt settlement for seven years. If you find one that is older on your report, have it removed by contacting the credit bureau.

The Credit Score Impact of Debt Consolidation

The fundamental concept of debt consolidation is the merging of multiple credit card balances or loan accounts. This naturally helps in the management of debt. Consequently, in the process, it lowers the interest expense. Typically, a borrower obtains a debt consolidation loan to pay off the individual debts. The borrower then follows it by focusing on repaying the loan as fast as possible; the fact that the rate of interest is usually far lower than average credit card APR, makes the task easier.

When You Make the Desperate Attempts

When you attempt to consolidate debt, you end up negatively impacting your credit score in a number of ways. The very first impact happens even before you obtain the debt consolidation loan. Irrespective of whether you apply for a new card to avail of a balance transfer offer or approach a private lender for a loan, the hard inquiry made by the card issuer or lender will cause a minor dip in your credit score. Even if you have a new credit card or open a personal loan account, you again influence your credit score. It may again lower your credit score temporarily as the new credit represents a new risk to the lender.

And When You Follow the Intelligent Practices

However, if you are regular in making the due payments on this card or loan, the credit score will climb back. Also, initially the credit score takes a tumble because the addition of a new card account or loan account lowers the average age of the credit enjoyed by you.

When loan accounts get progressively older and you are able to demonstrate a regular on-time repayment behavior, the credit score automatically climbs back. Borrowers will also be glad to know that taking on a new loan for debt consolidation, lowers credit utilization ratio. This is because now they pay off the credit card accounts fully.

The increased credit available boosts your credit score and negates some of the impacts suffered earlier. Also, the credit reporting bureaus positively interpret your regular repayments on the debt consolidation loan. This will also boost your credit score. Over a period of time, debt consolidation can actually get your credit score back on track as you make on-time payments and get rid of your debt.

Conclusion

Getting into a debt trap can be really scary and most people will be desperate to get out of it. While debt settlement seems to be a very attractive proposition as it reduces the total amount of debt to be repaid, there are usually severe repercussions on your credit score that may endure for as long as seven years. Debt consolidation, on the other hand, impacts your credit score far less and over time may actually help you to rebuild your credit report.

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