Credit Card Settlements Can Help Struggling Borrowers, but With Downsides

How does a credit card settlement affect your credit score? Settling your credit card debt can reduce overall debt, but there are some drawbacks.

Kathryn Underwood - Author

Mar. 15 2023, Published 9:16 a.m. ET

A man using a credit card
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Credit card debt can be a major burden. Is debt settlement the right solution?

Borrowers who have debt that they're struggling to repay may have some options, but beware that they can have negative consequences. If you've considered a credit card settlement on your debt, this is a legal option. It can get you out of debt quicker, but not without problems. How does a credit card settlement affect your credit score?

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If your credit score drops after settling your credit card debt, it's actually to be expected. As Chase explains, credit card companies may offer borrowers the chance to settle their debt. If you make a credit card settlement, your account will be updated with the term "settled" rather than "paid." This tells credit reporting bureaus important information.

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If you want credit card payments to be approved, staying current on bills is key. A settlement may or may not be the best move for you.

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What is a credit card settlement?

If you use a credit card and have an outstanding balance you aren't able to pay off in a reasonable amount of time, you might ask your credit card issuer for a settlement. Essentially, a credit card settlement is when the card company forgives a portion of the debt and allows you to pay an agreed-upon amount instead.

You might negotiate a credit card settlement because of recent unemployment or a medical leave of absence that make it hard to pay the balance in full. Whatever the cause of the hardship, you might pay a fixed amount in exchange for the company reporting your account as "settled" or "paid-settled."

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Settling credit card debt will often cause a drop in your credit score.

How do debt settlements work?

Credit card settlements, or any kind of debt settlements, are an option that some borrowers may have if they're struggling to pay down debts. It's a legal way to manage your debt. You agree to pay a portion of your balance and the card company agrees to mark it as "settled." Card companies may negotiate a settlement with borrowers in order to recoup some of what they've loaned rather than none of it.

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A suggestion would be that if you must make a credit card settlement, try to get the company to report your account balance as "paid in full." It may not be an option, and it isn't exactly true, but companies may be willing to do this to help you keep your credit score from dropping as much.

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How many points will a debt settlement make your credit score drop?

There isn't a fixed amount that your credit score will drop after a credit card settlement. The higher your initial credit score, the more your credit score may be impacted. The difference between the paid amount and the amount owed could impact the drop in your credit score as well.

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Source: Equifax Facebook

Consider your options for debt payoff before deciding to make a settlement with your credit card company.

Why does a credit card settlement affect your credit score?

Settling a credit card balance means you've paid less than the total amount owed. Most companies will report this as "settled" and not as "paid." This reflects poorly on your credit score because that monitors your trustworthiness in paying off debt on time as agreed, so a credit card settlement will affect your credit score negatively.

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As Chase notes, the credit reporting bureaus (Equifax, Experian, and TransUnion) will view a settlement as a negative event in your payment history. They can see it as proof that you were unable to pay a balance in full, resulting in a ding to your credit score. Record of the debt settlement remains on your credit report for up to seven years.

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Source: Unsplash/Towfiqu Barbhuiya

Paying off debt isn't easy, but if possible, it's preferable to a debt settlement.

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Is it better to settle or pay off your debt in full?

While a credit card settlement may seem appealing for the chance to "start over," it's always better to pay off your debt in full, if possible. Debt settlement is a tool that you shouldn't use unless you truly aren't able to pay the balance in full. Negotiating for a better interest rate may help you pay it off faster.

If you're facing a mountain of debt from credit cards and other creditors, you might feel hopeless. Debt settlement may ease the pain, but it will remain on your credit report for seven years. You could also focus your efforts using either the debt snowball or debt avalanche method for payoff.

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