Paying off your debt may require you to make some tough decisions. One of the hardest decisions you might have to make is to sacrifice your credit score for the sake of getting out of debt. Before you choose a debt relief option, consider how it will affect your credit score. Some options hurt your credit score more than others and that credit score impact may weigh into your decision. Three solutions that are often compared to each other are debt settlement, bankruptcy, and paying on your own.
Debt settlement, if you’re not familiar, is a debt repayment strategy where your creditors accept a lump-sum payment, that’s less than the outstanding balance, and full satisfaction for the debt. After accepting your payment, the creditor cancels the rest of the debt. This isn’t something creditors offer automatically. Instead it’s an arrangement you (or a debt settlement company) makes by negotiating with the creditor.
Paying off your balance at less than it’s face value sounds like a good proposition and it is. But, the downside is that your credit score will suffer. First, you have to be late on your payments before the creditor will agree to a settlement. A late payment can hurt your credit by 60 to 110 points. The further behind you get and the more accounts you’re delinquent on, the more your credit score is affected. Debt settlement, on top of the late payments, can cost 45 to 125 points, depending on your credit score before you settle your debt.
Through a Chapter 7 bankruptcy, the goal is to have most of your unsecured debt completely discharged. After discharge, you’re no longer responsible for the debt. The upside is that you can get out of debt and only pay the cost of filing bankruptcy, which is just a few hundred dollars. Bankruptcy is infamous for its affect on a filer’s credit score. Bankruptcy can end up costing you between 130 to 245 points. That’s a big drop.
Paying on your own:
Paying off debt on your own is often the hardest of all the solutions. It can also take the longest. But, the benefit is that your credit score can actually increase by paying debt on your own. That’s if your accounts are in good standing when you start paying your debt. However, if your accounts are already charged-off or with a collection agency, paying them off won’t benefit your score, but it won’t necessarily hurt your score either.
While some believe the credit scoring system has faults, the good thing is that a bad credit score can be rehabilitated. If you decide that debt settlement or bankruptcy is a better option for you, you can later improve your credit score by through credit repair strategies. As someone who’s goal is to get out of debt, you have to decide what’s most important – struggling with the debt and keep your good credit score or choosing a debt repayment scenario that temporarily costs your credit score.
This post was written by Eliza Collins, a guest writer specializing in personal finance topics like savings, debt relief as well as credit score improvement. You can read more of her articles at the debt settlement blog.