Your credit score is made up of several factors, each of which is weighted differently for credit reporting. The most substantial credit score factors are your payment history and credit utilization. Other items that determine your credit score are the length of your credit history, new lines of credit, and your credit mix.
Debts tied to an asset like a car loan or a mortgage have different settlement procedures and credit impacts from unsecured debts like credit cards and personal loans. Student loans have a range of settlement options depending on the type of loan, but settling will damage your credit regardless.
This makes each debt a little different in terms of settling.
Is it better to settle a debt or pay in full? It’s better for your credit score to pay a debt in full, but better for your wallet to settle a debt for less than you owe if you don’t have the money to pay. Ultimately, you have to decide if you can afford the cost to your personal finances versus the cost to your credit.
Keep in mind, missed loan payments have already damaged your credit score. If you’ve defaulted on a student loan (or have multiple lapsed payments on other loan types), settling can actually give you the relief to start rebuilding your credit.
Here are the 5 most common debts that can be settled, as well as how much they can damage your credit score if settled:
Student loan debt
Credit card debt
1. Student loan debt
Can debt settlement hurt your credit score? Yes, settling student loan debt for less than you owe will hurt your credit score.
Your payment history reflects the status of each loan on your credit report. When you settle, this status shows that you settled for less than you owed, which creditors don’t want to see. However, that hit is less impactful than a history of missed payments.
This is important to keep in mind if you are considering a strategic default in hopes of settling. Be aware that your credit will take a significant hit from the defaulted status and the settlement, making it harder to get other types of loans in the future and raising potential interest rates.
Many people have questions about “pay for delete” arrangements when it comes to removing a settled debt or missed payment from your credit report. This doesn’t happen for student loans, and many experts believe it’s becoming outdated overall.
Here’s the bottom line: If you have the option to continue timely payments on your student loans, that’s probably the best choice. It’s very unlikely you will reach a settlement that offsets the costs of defaulting and credit damage.
If you’re already in default, settlement may be a good option, especially on private student loans. (Rehabilitation can be another good option for federal loans; more on that later in this article.)
Learn More: How to Remove Federal Student Loans From Credit Report
2. Credit card debt
Settling a credit card account can relieve you from expensive interest and take a sizable chunk out of your outstanding credit card balance. However, settling that debt can drastically affect your credit.
The damage to your credit score from a settled debt is due to two factors:
Your credit score will indicate you settled for less than you owed, which lenders don’t like to see.
The card will have been closed in order to settle. A closed account can affect your credit score by reducing the length of your credit history.
If settling with your credit card issuer isn’t an option, consider a balance transfer or debt consolidation loan if you can get it. You’ll start fresh with a new, single loan with one monthly payment and a (likely) lower interest rate.
3. Auto loan
Auto loan lenders tend to repossess a car if your auto loan goes bad. However, repossession is costly for the lender, and they aren’t likely to recoup the total amount of the loan in resale.
This leaves room for you to negotiate settlement offers. While your credit will take a hit by settling, the damage might be a lot less compared to the loss of your car as well as a hit on your credit due to repossession.
4. Personal loan
You can often settle personal loans for 50% or less of the remaining loan amount, depending on the lender.
In this case, timing is everything. The closer a lender is to selling your debt to a collection agency or charging it off completely, the more likely you will get a good deal.
Here’s why: If the lender “charges off” the debt, they close the account without getting anything. A charge-off is a credit score killer, even more than a settlement. If you offer to settle for even half, they’ll probably accept since it’s better than nothing.
Unfortunately, paying a loan just before it’s charged off also means racking up missed payments. Like with student loans, the missed payments may cost you more in the long run than continuing to pay back your debt.
Like auto loans, a mortgage is tied to a physical asset: a house. Homeowners that do not pay their mortgages often end up foreclosing. But like repossessing a car, foreclosure is costly for your lender.
On the other hand, a mortgage is the most valuable credit line you can have on your credit report. As a result, a foreclosure is the most costly derogatory mark.
If you can negotiate a mortgage settlement with your lender — which is very difficult to do — you’ll probably avoid a much bigger hit to your credit than if you foreclosed.