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How Will Debt Settlement Affect My Credit Score?

Tara Mastroeni
Written by Tara Mastroeni
Dawn Daniels
Edited by Dawn Daniels
Updated on: May 30, 2025 Content was accurate at the time of publication.
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Debt settlement is a process that allows you to settle your debts for less than what you owe. However, it can negatively impact your credit for up to seven years. Before you take this step, it’s important to educate yourself on both the benefits and risks.

Key takeaways
  • Debt settlement allows you to resolve your debts by paying less than what you owe.
  • This process has some downsides, including negatively impacting your credit score for seven years.
  • If you decide to go this route, it’s possible to negotiate with creditors on your own rather than hiring a debt settlement company.

How debt settlement affects your credit

While settling your debts is better than not paying at all, it can still hurt your credit history. 

Settled accounts may negatively impact your credit report for up to seven years.

An account that was settled remains on your credit report with a status of “settled.” This entry will appear for seven years from the date of your first missed payment resulting in settlement.

This could potentially make it challenging to get approved for new forms of credit in the future, like a mortgage or credit card.

Missing payments while your debt is settled will ding your credit score.

Most debt settlement companies require you to stop making payments while they work with your creditors. The goal is to give them negotiating power — some creditors will not settle for less than the full amount unless you’ve already fallen behind on your payments.

This means you’re taking a risk by stopping payments on the accounts, and your credit score will likely drop.

However, if you’re considering debt settlement, there’s a good chance that you’re in a tough spot financially and may already be missing payments. How much your credit score is affected will depend in part on whether you’re already seeing a score dropped from missed payments.

In either case, a reputable company should disclose the risk to your credit score when settling debt.

Fees can stack up with no guarantee that your debt will be reduced.

Debt settlement agencies may work out an agreement with your creditors that requires you to make payments for a long time before your debts are settled. Be sure to review your budget and long-term financial plans before agreeing to work with a debt settlement company so you don’t end up quitting the repayment program.

Debt settlement companies may also try to settle smaller credit accounts first, which can cause fees and interest to stack up on your larger debts.

You may have to pay taxes on your settled debts.

Credit card companies and other creditors may report debt settled for less than the full amount to the IRS. Depending on the type and amount of debt, you could potentially be responsible for paying taxes on the difference between the amount you settled for and your full balance owed, as the IRS considers this to be taxable income.

How debt settlement works

Your first step is to confirm that you actually owe the debt. If you’re unsure if you owe a debt, you have the right to request validation information from the collector.

Once you’ve confirmed that you owe money, there are two ways to negotiate a debt settlement: You can either hire a debt settlement company to negotiate on your behalf or you can work with your creditors yourself.

Negotiating on your own

To negotiate a settlement agreement with your creditors:

  • Make a budget: Determine how much you can afford to spend on the debt. Think about how much you can afford to pay each month and the total amount that you’re willing to give each creditor.
  • Contact your creditors: Contact each creditor and explain your financial situation, particularly any hardships making it difficult for you to keep up with your payments. Then, ask to negotiate a debt settlement agreement.
  • Negotiate a settlement agreement: You can negotiate a payment plan or a lump sum settlement. In either case, it’s a good idea to start by offering less than you can afford to spend, so you have some bargaining room. 
  • Get it in writing: Make sure to get the terms of your debt settlement agreement in writing, including whether your debt will be considered settled once you complete the agreement and whether you can be sued at any time.
  • Follow the agreement: Once an agreement is in place, stick to it. This means making your payments as scheduled and fulfilling any other obligations outlined in the agreement.

Working with a debt settlement company

If you don’t have time to contact your creditors, you can hire a debt settlement company to negotiate an agreement on your behalf. Here’s how to make it happen:

  • Find a reputable company: Scams are fairly common in the debt settlement industry, so be sure to do your research by reading available reviews and consumer complaints. Avoid any company that guarantees to settle all your debts or requests that you pay fees upfront  
  • Follow their instructions: Do your best to follow any instructions given to you by the debt settlement company while they’re negotiating your agreement. Your compliance may affect their bargaining power.
  • Review the settlement agreement: Once a debt settlement agreement has been reached, ask to review the terms in writing. Make sure you understand the agreement because you’ll be responsible for following it once it has been signed. If you have questions, don’t hesitate to contact the debt settlement company.
  • Follow the agreement: The last and most important step in the process is following the agreement carefully.

How to spot debt settlement scams

If you’re searching for a debt settlement company to work with, beware of predatory debt relief scams that target consumers with large amounts of debt.

Per the Federal Trade Commission, you’ll want to watch out for the following red flags:

  • Requires that you pay fees up front before negotiating with your creditors
  • Claims it is working with a “new government program”
  • Makes guarantees up front
  • Advises you to stop all communications with your creditors and doesn’t explain the impact that can have on your case
  • Promises it can stop all lawsuits and collection calls
  • Asserts that debts can be settled for very cheap

If you want to avoid scams, consider instead working with a nonprofit credit counseling organization. You can find a list of reputable credit counseling agencies on the Department of Justice’s website.

4 reasons debt settlement may be worth it

For all of the potential negatives of debt settlement, it still might be worth doing.

1. Your credit score should recover

While your credit score will likely take an initial hit, it should recover over several years. Recovery will happen faster if you can show you’re a responsible borrower by doing things such as paying on time and not using too much of your credit limit.

2. A settled account is better than a defaulted one

A settled account is viewed more favorably than one that has been defaulted on and written off by a credit card company or another lender.

3. You could pay less

If you’re successful in your settlement ventures, you’ll end up paying less than what you originally owed. This can free up your cash flow and allow you to build up your savings or pay down other debts not included in the settlement.

4. You may avoid bankruptcy

While debt settlement and bankruptcy, specifically Chapter 13 (aka the “wage earner’s plan”), have some similarities, one of the biggest differences is that bankruptcy is a matter of public record. On the other hand, your credit report and score are more personal.

The advantage of bankruptcy, however, is that some forms (such as Chapter 7) may allow borrowers to completely eliminate their debt.

Alternatives to debt settlement

If you decide that pursuing debt settlement isn’t the right choice for you, there are several alternatives to consider, including:

Debt consolidation

Debt consolidation involves taking out a new debt consolidation loan and using it to pay off your existing debts. While this method won’t reduce the total amount of debt that you owe, it can be a way to lower your interest rate and streamline your payment due dates.

Balance transfer credit card

If you have mainly credit card debt, you may be able to use a balance transfer credit card to pay off your debts without accruing additional interest. Usually available to those with good or excellent credit scores, balance transfer cards allow you to transfer existing balances onto them while offering a 0% APR introductory rate.

However, you’ll want to be careful to pay off your debts in full before the introductory rate period expires. After that, the interest rates on these credit cards tend to be on the higher side.

Debt management plan

A debt management plan is a common debt payoff strategy offered by nonprofit credit counselors. This method allows certified credit counselors to negotiate with your creditors on your behalf and come up with a payment plan, usually lasting three to five years.

Bankruptcy

If you truly don’t have the ability to repay your debts, filing for bankruptcy may be a smart option. That said, bankruptcy is very serious and is often considered a last resort. It stays on your credit report for seven to 10 years, depending on the type of bankruptcy and has a greater negative impact on your score than does debt settlement.

Frequently asked questions

Debt settlement may not totally ruin your credit score, but it will likely negatively impact it for seven years. Some people see a drop of 100 points or more.

Some downsides of debt settlement are:

  • You may not be able to settle all of your debts. It is up to each creditor to decide if they’ll take less than the full amount owed.
  • Debt settlement negatively impacts your credit for seven years, making it hard to borrow again in the future.
  • You may incur additional interest charges and fees while negotiating a debt settlement plan
  • You may have to pay taxes on the difference between the debt settlement amount and your total balance owed.

If possible, it’s better to pay debts in full because doing so won’t negatively impact your credit score. That said, if you can’t afford to pay off your debts fully, debt settlement allows you to resolve the debt by paying less than what you owe.

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