- All forms of debt relief will likely cause a temporary decline in your credit score.
- Keeping credit card balances maxed out hurt your credit nearly as much as a missed payment.
- Debt settlement could raise your score faster than paying the minimum amount on maxed-out credit cards but never missing a payment.
Credit scores are marketed as the end all and be all of your financial well-being. Consumers are led to believe that great credit will open doors, granting both power and happiness. Lenders create fear that if you use any debt relief program, especially debt settlement, that it will do irreparable harm to your credit and your finances.
The problem with this myth is that it can keep you in perpetual debt. Financially stuck for decades, making minimum payments on high-interest debt, without the means to change your financial destiny. Here is the truth about credit and how debt relief will impact your credit:
How Companies Calculate Your Credit Score
Credit scoring agencies are for-profit companies that sell your credit score to lenders and other businesses, who use the data to make application decisions. There are two primary credit scoring companies: FICO and Vantage. While each uses independent algorithms, the data points they rely on to create your score are very similar.
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The five key factors that comprise your credit score include:
- Bill payment history
- Balance to available credit or utilization ratio
- Length of credit history
- New accounts and recent applications
- Type of credit (loans versus lines of credit)
Payment history carries the most weight. FICO applies 35% of your score to payment history, with credit utilization following closely at 30%. Having too much debt can be as impactful as missing a payment.
What Lenders Care About
Lenders use credit to gauge the risk of non-payment and is only the primary decision-making factor for credit card applications. All other loans rely on multiple financial measures beyond your credit score.
Lenders also evaluate employment history, income, current debt levels (measured by your credit report), collateral for the loan, and the availability of other assets.
How Debt Relief Impacts Your Credit?
Debt relief can help consumers struggling with existing debts.
Whether you face a temporary or long-term financial hardship, debt relief can help when you battle to pay debts. The struggle to make payments on time is also an indicator that your current financial situation already impacts your credit.
Often, by the time you consider debt relief, you have already missed payments, opened new accounts to juggle debt, or maxed out credit cards, which all harm your credit score. Debt relief options like credit counseling or debt settlement mean closing accounts, further affecting your credit at the start of your journey.
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How Long Does It Take for Credit to Recover?
Derogatory information, like late payments, remain son your credit file for seven years. When you catch an account, the seven-year clock starts from the last missed payment. Never bringing the account current means the seven-year clock starts from the first missed payment.
Filing bankruptcy has the most significant impact on your credit, lasting for up to ten years. It could also make it more challenging to borrow money in the future because you must attest to filing any time an application asked the bankruptcy question.
It is hard to miss the first payment. You fear losing control of your finances, not having access to credit, and the rejection of a future application. Yet, the reality is you might not have a need to apply for new credit right away, and failing to act could leave you struggling for years to come.
What is the credit impact of debt settlement?
All forms of debt relief will cause an initial and temporary decline in your credit score. Late payments remain on your credit file for seven years but have less impact on your score as time passes.
Will debt settlement ruin my credit?
Consumers seeking payment relief through debt settlement often have damaged credit already. Late payments and high balances, in relation to your credit limit, both significantly impact your score. Debt settlement could further reduce your credit score for a year or more. However, as you pay off creditors, your score will improve.
How long will my credit be affected after debt settlement?
Debt settlement can eliminate credit card bills, medical obligations, and other unsecured debt within 24 to 48 months. Late payments remain on your credit for seven years from the first missed payment. Meaning the bulk of the damage to your credit will occur while you are enrolled in the program,giving you the opportunity for a fresh start after program completion.