Credit card debt can be overwhelming; for those who cannot pay, settling the debt might appear as an option. While settlement does allow you to close an account by paying less than the full balance, it has very important implications for your credit score; and understanding how will help you decide appropriately at times for financial dealings that will take you toward rebuilding your credit after settling a credit card debt.
In credit card settlement, you make an agreement with your credit card company to settle some of the money that you owe on your outstanding balance. In this settlement, the lender receives the reduced amount as a “final” payment, which closes the account with an agreed-upon payment, generally after a person cannot pay full payments due to difficult financial conditions.
Settlement credit cards affect your credit score in three major ways. Here’s an in-depth explanation of how your credit profile changes:
A credit report will display the status when a debt has been paid with “settled” and not “paid in full.” It is considered adverse by the scoring models because this means you could not fulfill the full obligation on the debt. It can be on your report for seven years and will go against your creditworthiness.
Credit bureaus include CIBIL, Experian, and Equifax when a settled account is considered for credit score calculation. Your credit card settlement may send your score to the dumps since it may fall, and its amount will depend solely on past credit history, amount settled, and more. In most cases, after settlement, your score usually goes down from 75 to 125 or more, which will also be dependent on past financial history as well as on the scale of settlement.
A paid account on your credit report makes you appear like a riskier borrower. Lenders perceive it as a signal that you might not be able to pay off debts, which could result in higher interest rates or even outright rejection of future loan applications. This could affect everything from credit cards to mortgages.
Settlement is an indicator of financial instability, and it raises a red flag for creditors. The history of your debt payments indicates the possibility of repayment of future debts to the financial institutions. Settling a debt gives the lenders the signal that you could not repay your debt in full, hence lowering their confidence in your credit management skills.
The impact of settlement on your credit score will depend on the situation. Some key factors include:
A paid account will be on your credit report for as long as seven years. As this will naturally impact your potential to obtain more credit, this will slowly lose its power as you develop an excellent credit record and pay other debts responsibly over time.
If you have already settled a debt, there are proactive steps that you can take to rebuild your credit score over time:
Your payment history counts for a substantial percentage of your credit score. Paying utility bills and any other loans on time will help your creditworthiness.
Pay back the existing one before getting the new credit in your hand, which shows one is financially responsible and disciplined too.
A secured credit card can be an excellent means to rebuild your credit. Secured credit cards require a security deposit, and they report to the credit bureaus; therefore, you will have the opportunity to develop a positive payment history.
Credit utilization is the percentage of credit utilized in relation to the total amount of credit that is available to you. Lowering your utilization below 30% will also have a good effect on your credit score.
Review your credit report to monitor your progress and ensure there are no errors. If your report still shows a settled account as “open” or “unpaid,” contact the credit bureau or the creditor to correct the error.
If you’re considering settling your credit card debt but want to avoid damaging your credit score, explore these alternatives:
A debt consolidation loan would combine the total of many debts into just one with a lower interest rate and easier payment while maintaining your credit score.
Although credit card settlement might become an absolute requirement in getting out of debt, it’s quite important to note how such action will influence the credit score as well as loans that might become unavailable to one in the near future. However, if all things go correctly and financially and one keeps maintaining responsible habits financially, they would slowly recover from their damaged credit standing.
Que: Will a settled debt completely prevent me from getting a loan in the future?
Ans: Not necessarily, but it will make it more challenging. Lenders will consider other factors, such as your income, credit score, and current financial situation.
Que: Can I remove the settled status from my credit report?
Ans: In most cases, a settled account will remain on your credit report for seven years. However, you can dispute inaccuracies with the credit bureau if you believe there’s an error.
Que: Is it better to settle the debt or let it go into collections?
Ans: Settling is generally better than allowing a debt to go into collections, as collections accounts can have a more severe and lasting impact on your credit score.
Que: How much can my credit score drop due to settlement?
Ans: While this varies, it’s common for scores to drop by 75-125 points or more. The impact depends on your credit history, the amount settled, and other factors.
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Founded in 2015, Ahk Tips is a New Delhi-based financial advisor specializing in debt relief and loan management solutions.
