Credit and Debt Blog

(Dee from Colorado) I was told that a settlement I made on my credit card debt will reflect more negatively on my credit report than filing for bankrupsy. Is that true?

Dee, neither a settlement nor a bankruptcy will have a positive impact on your credit score. Both will cause a drop in your score and will limit your credit opportunities for years to come.

What may be more important than your credit in this type of situation is the potential for adverse legal action. Each action has an impact on your exposure to judgments. Here is how they differ:

Debt Settlement

Settling on a debt can prevent legal action if, and only if you reach an agreement with that creditor and meet the terms of that agreement. That means that you will need to get the creditor (or the debt collector) to agree to accept a smaller payment in exchange for canceling the rest of the debt. If you owe $5,000 on a debt, you should expect to have at least $2,000 to even begin the negotiation process. Be prepared for the lender to expect at least 60% payoff in an immediate lump sum payment.

If you have several creditors that may pursue judgments, then it is much less likely that you will be able to come up with the amount of money necessary to settle. Settlements need to be made within the first several months of collection activity in order to prevent legal action. That is one of the reasons why debt settlement companies are so ineffective. After paying over $1,000 in up-front fees, it may take years for the debtor to ever complete the agreement, of which many of their creditors are likely to already file for legal action.

In terms of negative credit reporting, a settlement is slightly better than not repaying the debt at all, but not much better. You might be surprised at how little your score increases for closing an account through a settlement. The older the account is, the fewer points you will gain through settlement. That negative information will remain on your credit report for seven years.

Bankruptcy

Bankruptcy might not be the answer if you only have one debt. Where bankruptcy is most effective is when you  owe substantial amounts of money to several creditors. If you are considered insolvent, or completely unable to repay your debt, then you might be better off speaking with qualified legal counsel about gaining protection from creditors through bankruptcy.

You might be surprised at how bankruptcy impacts your credit. Your credit score will be calculated based on your credit history, but it will be compared against those of your peers.

Your credit score will be calculated using one of ten different credit scoring formulas known as scorecards. Although it is believed that the formulas are basically the same, more weight or less weight may be given to some of your credit records as opposed to someone who had not filed for bankruptcy.

If this sounds confusing, that’s because it is. You will not be scored against the general population. Instead, you will be scored against others that have filed for bankruptcy within a specified time period.

As  a result, your credit score could be lower through bankruptcy, or it could be higher within a short period of time. Depending on the specifics of your bankruptcy filing, it could remain on your credit report for seven to ten years as a public record.

Related Links

Bankruptcy Basics

Pros and Cons of Debt Settlement