Will Debt Relief Really Tank Your Credit Score?

If you’re drowning in debt, debt relief could be a way to reduce some of the burden, or at least give you a more manageable payment plan.

The process, which is also frequently called "debt settlement,” involves negotiating with creditors to settle your debt for less than the total amount you owe. It can be a complicated and lengthy endeavor, which is why some individuals choose to pay a debt relief company to handle the negotiations.

While debt relief may be able to help relieve the stress of overwhelming debt, the strategy does come with downsides, including how it can affect your credit. In fact, the idea that debt relief will ruin your credit scores is one of consumers’ primary concerns about the process, since a low credit score could determine whether they can take out more loans in the future, as well as things like approval for rental leases and rates for auto insurance. It comes down to which is the more urgent priority given your current financial situation — is it more important to deal with overwhelming debt or to preserve your credit score?

How does debt relief affect your credit score?

The FICO score, the most widely used credit score in the U.S., ignores any mention of signing up for debt relief plans on your credit report, Ethan Dornhelm, vice president of FICO Scores and Predictive Analytics at FICO, told Money in an emailed statement. So it won’t hurt your FICO score if you enroll with a debt relief program.

But the actions you take based on that debt relief company’s recommendations can (and in all likelihood will) affect your score early in the process.

When you work with a debt relief company to settle your debts, they will likely recommend that you stop making payments completely in order to build leverage to negotiate. Instead, you’ll make a monthly deposit to a savings account to build up money for the debt relief company to make settlement offers. Halting payments lowers your credit score. And not paying your creditors according to the original terms — which is what happens if a debt relief company negotiates a settlement — will be noted on your credit report.

“Choosing to make partial payments or agreeing to settle for less than the full amount on accounts may be regarded negatively by the FICO scoring model,” Dornhelm explained. “Additionally, any late payments occurring either before or after you initiated a debt relief agreement may also be regarded negatively.”

That said, if you’ve already fallen behind on payments or are seriously struggling to keep up with the minimum payments, it’s possible your credit score may suffer before you even enroll with a debt relief company. And while settled accounts will appear on your credit report, that notation is still better than having ongoing, unresolved delinquent accounts.

How much will your credit score drop?

Settling your debts could be the quickest way for you to get a handle on what you owe. Still, the possible effect on your credit can be significant.

“Your score is going to almost certainly be in the subprime range,” says Rod Griffin, senior director of consumer education and advocacy at Experian, one of the three major credit bureaus. The Consumer Financial Protection Bureau defines subprime credit scores as those between 580 and 619 and “deep subprime” as those below 580.

Pinpointing exactly how much a credit score will fall as the result of debt relief is nearly impossible, since it will depend on factors like how much debt you’re settling, how your creditors report the settlement and the current state of your credit.

“It’s going to be different for everybody,” explains Jeff Richardson, senior vice president and head of marketing at VantageScore, another of the credit scores used by creditors. The credit score of someone who has several loans, some of which they continue paying and others that they settle, will likely recover quicker from debt relief than someone who only has a few credit accounts and is settling most (or all) of them.

Someone with a high credit score — say 670 or above — could be impacted more than someone who is below the 600-level, Richardson says, though he adds that someone with a high credit score likely isn’t in a position where they need to work with a debt relief company. That’s because credit card debt relief is a more significant intervention than debt management options like consolidation or payment plans, so consumers typically don’t pursue it unless they’re already struggling to keep up with their bills.

Debt.org, which provides free educational information on paying off debt, reports that if your credit score is above 700, it could fall as much as 200 points or more, and if it’s below 700, it could see a drop of 100 points or more.

How soon will your credit score be affected and when will it recover?

After the negative information is reported to the credit bureaus, you can expect to see your score affected within 30 days, Richardson says. But the specific timing will depend on where you get your score: Some providers refresh their scores multiple times a month and some refresh once a month, he adds.

If settling some of your debts helps you to regain control of your bills and you start making regular, on-time payments on other credit accounts, that should help your score begin to recover. Depending on your outstanding balances and credit limit, settling accounts could help lower your credit utilization, which is typically a good thing in credit scoring models, credit experts say. Still, because payment history is the most important part of your credit score, it will take a while for your score to fully rebound from the delinquencies.

“Eventually, the accounts that were settled will fall off their credit report entirely as it ages,” Denise Dunckel Morse, chief executive officer of the American Association for Debt Resolution (AADR), told Money in an emailed statement. “Late payments and delinquent accounts typically fall off a credit report after seven years.”

Is debt relief a good idea?

Dunckel Morse says that many individuals seeking debt resolution face significant financial hardships, often through no fault of their own, such as a sudden illness or family loss.

“When a consumer first comes to a debt resolution provider, they typically owe over $25,000 in unsecured debt and are already behind on at least one, and in many cases the majority of the seven or more accounts they hold,” she says. “This situation puts a strain on their credit scores which are generally in the mid-500s.”

In other words, by the time a person is in a situation where they need to settle a debt, their payments are likely very behind and they may be facing collections, which means their credit scores are probably already very low, Griffin says. At this point, they may be facing two options: debt settlement or bankruptcy.

“Debt settlement is better than bankruptcy, but [bankruptcy is] probably a very close second,” Griffin says.

About three quarters of debt relief customers had at least one account successfully settled between 2011 and 2020, according to a report commissioned by the AADR and published by the Harvard Kennedy School. Of that group, the average debt savings were about 50% on settled accounts (before accounting for fees).

Dunckel Morse says while account settlements can impact a consumer’s credit, the effect is “less dire” than what they’d experience with bankruptcy over the long term. “After graduation from a debt resolution program, most clients never need the service again and their credit scores recover,” she says.

The type of bankruptcy you’re pursuing can make a difference in your decision, too. Chapter 7 bankruptcy allows most of your unsecured debts to be discharged, but you’ll have to meet a means test to qualify. If you earn too much income relative to your debts, this path may not be an option for you. For those who do qualify, it’s an almost guaranteed way out of debt, with some 95% of cases resulting in a discharge, according to a 2021 analysis by Freedom Debt Relief of data from the Federal Judicial Center, a research and education agency of the government’s judicial branch. .

Chapter 13 bankruptcy, on the other hand, requires you to complete a years-long, court-approved payment plan to clear your debts. But if you fall behind on these payments, the court could dismiss your case. In 2023, about half of Chapter 13 cases that were closed ended in success, with the consumer getting a discharge after completing their payment plan, according to federal court data. Compared with debt settlement, this option protects you from creditor collections actions, but it can take longer than debt settlement to complete.

Natalie Jean-Baptiste, a staff attorney at The Legal Aid Society covering bankruptcy, says her general gauge is that if someone is facing collections lawsuits and wage garnishments, or they’ve fallen behind $10,000 or more of unsecured debt that they can’t pay back within five years, bankruptcy may make sense.

“Especially for the low-income population, bankruptcy is the better option,” she adds.

But both Chapter 13 bankruptcy and the delinquent accounts that typically precede debt settlement will stay on your credit report as a negative item for seven years (and for Chapter 7, it’s 10 years). If you’re worried about protecting your credit and there is any other way you might be able to pay off your debt — like debt consolidation, working with a credit counselor or tapping your home equity — you likely want to go with one of those alternatives first.

More from Money:

5 Must-Ask Questions Before You Sign Up for a Debt Relief Program

How Does Debt Consolidation Affect Your Credit?

You Might Be Using the Wrong Strategy to Pay Down Your Debt