Debt Settlement Impact on Credit Scores

How debt settlement impacts credit scores and an individual’s ability to get a mortgage or any loan/lease:

There is so much confusion and misinformation when it comes to credit scores regarding so many topics! Many consumers in the past 5 years have resorted to varied tactics to reduce their debt load. Even those who had the means to pay mortgages, credit card balances, and more decided to walk away from their obligations or pay less to their creditor. “Debt Settlement” (DS) is one of the many choices available to those who can’t afford to pay their debts or some that pretend they can’t afford to pay their debts. When a consumer owes a credit card company or mortgage bank a set amount of money if they default on their obligation or have been approved for a short sale it is considered a settled account once the lowered approved payment is made. Whether you have been told “This won’t hurt your credit much” or “This will only impact your credit score for a few years” both of these statements are completely false. When you settle an account that is listed on your credit report it can drop scores hundreds of points and take 3-7 years to reach score recovery. The lower your credit score prior to the settled account the less of a score deduction you will have. Since having a poor credit score already shows a much higher risk borrower the score does not need to drop much more to express the new level of risk. On the other hand if you have excellent scores and suddenly you default and settle on an account the score must drop dramatically to reflect your new level of risk to a lender.

For example:

If you started at a 680 FICO which is considered average credit your score could drop to a 610-630 after a settlement or short sale. It would take 3 years to recover from this event and get back to the 680.
If you started at a 780, which is considered excellent credit, your score could drop down to a 655-675 and take 7 years to recover and reach the 780 again.

When it comes to mortgages there are loans that applicants can qualify for with low credit scores but that could be at a much higher cost to the borrower. If an applicant was in need of a jumbo loan they might be denied completely if the scores were less than excellent! Before choosing DS consumers should analyze their future loan goals and credit score consequences. Saving pennies in the short term may lead to costing dollars over the life of a mortgage.


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