Hannah Locklear | December 20, 2022
Summary: It may take 6-24 months to improve your credit score after debt settlement, but it depends on your credit history and financial circumstances. Settling a debt will not increase your credit score, but it won’t hurt it as much as not paying at all. Debt settlement is a good option if you are struggling to make ends meet and get back on track financially. You can end up saving money and put yourself in a position to improve your credit score in the long run.
For some of us, there may be a point in our lives in which we will struggle financially. Debts continue to pile up, and you may be unable to find the money to pay them off. In times like this, you may be able to settle your debt with your creditor or debt collector.
While debt settlement ensures that debt collectors will cease contacting you, it will also harm your credit score. That being said, nothing hurts your credit score more than failing to pay back what you owe.
Keep reading to find out how long it takes to improve your credit score after a debt settlement. But first, what exactly is debt settlement?
Traditionally, debt settlement involves working with a debt settlement agency to settle your debts for a fraction of their total value. You start by providing the company with a list of all the obligations you want to pay. The agency will create a payment plan for you, and you’ll send them a specific amount of money each month, which they’ll put in a dedicated account for you.
However, you can also work out a debt settlement on your own without enrolling in a debt settlement program. SoloSettle can help you with this process.
While working with a debt settlement agency, you stop paying your creditors. Once you have enough money in your settlement bank account, the debt settlement company will start negotiating with your creditors one by one. You'll pay the amount due when they reach a settlement agreement with your lender.
The process repeats until you settle all of your debts and graduate from the program.
Beware: some debt settlement agencies are scammy and end up making your financial situation even worse. Some states have even had to create new legislation to govern the practices of debt settlement companies.
With SoloSettle, you can focus on one debt at a time and reach a settlement agreement on your own terms and at your own pace. In the process, you’ll end up saving money and giving yourself a financial refresh.
Check out this video to learn more about the benefits of debt settlement and how to settle a debt on your own:
Now that you have a better understanding of how debt settlement works, let’s explore how it can affect your credit.
The disadvantage of obtaining a debt settlement is that it negatively impacts your credit score, which is determined based on records of your accounts and loans, the terms of agreement, late payments, outstanding balances, and credit limits.
Your credit score is your creditworthiness. A good credit score is only applied to accounts that do not have late payments and are paid off according to the original terms. High creditworthiness means a lower risk for the lender or creditor, as it demonstrates that you are capable of making payments on time. On the other hand, a low credit score indicates that you are a delinquent debtor.
While obtaining a debt settlement will allow you to settle with your creditor and end your obligation on good terms, it will most likely harm your credit score as you were only able to pay a portion of your debt. Additionally, debt settlement does not erase the fact that you are a delinquent debtor as you were unable to pay your debts according to your contract or credit agreement.
As such, when your creditor reports the closure of your account due to a debt settlement, it modifies the original contract of agreement, and your credit score is affected.
You should anticipate a lower credit score after your debt settlement.
That being said, there are many factors that play into how much your credit score will drop after debt settlement. Here are some:
Most importantly, bear in mind that settling a debt will have less of an impact on your credit score than no payment at all. It also puts you in a better position to stay on top of future payments and build your credit further.
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Debt settlement will remain on your credit report for seven years. This means that for those seven years, your settled accounts will affect your creditworthiness.
Lenders usually look at your recent payment history. There is a high probability that you will be affected for a couple of months or even years after settling your debts. However, a debt settlement does not mean that your life needs to stop. You can begin rebuilding your credit score little by little.
Your credit score will usually take between 6-24 months to improve. It depends on how poor your credit score is after debt settlement. Some individuals have testified that their application for a mortgage was approved after three months of debt settlement. Some needed years before they could get a new credit card or loan.
It varies case by case, and it is difficult to determine the exact timeframe required to improve your credit score. The time it takes to repair your credit score will depend primarily on your credit history.
Consider the example below.
Example: After many months of missed payments, Evan was sued by his credit card company for a debt of $5,000. He used SoloSuit to respond to the lawsuit, giving himself time to work out a settlement plan. After analyzing his income and other financial obligations, Evan determined he could afford to pay off 80% of the debt, or $4,000. Evan utilized SoloSettle to start the settlement negotiation process and sent an initial offer at 50% of the debt, or $2,500. Evan’s creditor sent a counter offer, and after a few rounds of negotiating, they reached an agreement of $3,500! Evan saved hundreds of dollars and gave himself a new financial foundation to build his credit back up.
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6 Months or Less: There is a possibility that if you have successfully paid off most of your debts and have settled accounts, creditors may still consider you a good debtor who can pay debts on time. If you still have open accounts after debt settlement with good records, this may help you get a credit rebound and improve your credit score. Even if you have a settled account the total assessment of your credit history can outweigh this by demonstrating that you have strong, positive credit, and your credit score could improve within the next six months or less.
12 - 24 Months: If your credit history reflects that you are a delinquent debtor, you have not paid off any part of your debt, there were a lot of late payments, or if it takes you years to settle your old debts you will have an extended period to wait before your credit score improves. A poor credit history tells creditors that you are a risk, and it will probably take 12-24 months for you to improve your credit score.
Remember that as your settled accounts age, their effect on your credit report will diminish even if they are still apparent. Take the initiative not to incur new debts, and your credit score will slowly improve. It will not improve overnight, so relax and do your best to become a wise debtor during this time. Avoid obtaining new debts while you are in the period of rebuilding your credit score.
A bad credit score will pass, and this chapter of your life will only last for a couple of years. Follow the advice provided here, and you will slowly make your way to a better credit score.
There is a common misconception that debt settlement will ruin any chances of obtaining a credit card in the future. While it may be difficult to open a new line of credit with a lower credit score, debt settlement does not prevent you from getting a new credit card in the future.
It may take some time to build your credit score back up to the point where you will be approved for a new credit card, but that doesn’t make it impossible or unfeasible. In fact, applying for a new credit card and staying on top of your payments can actually help you increase your credit score after debt settlement.
It’s a similar situation for people who are looking to buy a house after debt settlement.
Technically, you can buy a house at any time after debt settlement. That being said, it might not be the best move, and it could be difficult to get the financial assistance that is generally required to purchase a home.
Since a debt settlement typically remains on your credit score for seven years, it can be difficult to find a lender who is willing to help right away.
However, if you stay on top of your financial obligations and prove that you are a trustworthy borrower, you can surely find a lender who is willing to work with you.
Generally, if you have settled a debt for less than the original amount you owed, then the amount of the forgiven debt is taxable. You must report any canceled, forgiven, or settled debt to the IRS on your tax return for the year it occurred.
Exclusions to paying taxes on debt settlement include the following:
Similarly, exceptions to paying taxes on debt settlement may apply, such as:
So, before you settle a debt with your creditor or a debt collector, consider the tax implications. Chances are you’ll have to pay the difference in taxes the following year.
Let’s take a look at an example.
Example: Janice owed LVNV Funding $5,000. She used SoloSettle to settle her debt with LVNV Funding for just $3,000. Since the debt came from using a credit card, Janice was not eligible for any of the tax exclusions or exceptions of debt forgiveness. As a result, she had to report the $2,000 difference to the IRS as part of her income the following year and pay taxes on it.
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