Money Health

Debt Settlement and the Road Back to FICO® Score Recovery

The Road Back to FICO Recovery
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I remember seeing this cartoon that shows a man on his knee asking a woman to marry him. The cartoon bubble has her replying that it depends on his credit score. References like this in our pop culture highlight consumers’ awareness of credit scores and how important credit scores have become in our lives. At Freedom Debt Relief, this shows up when our prospects want to better understand what could happen to their credit score as they go through debt settlement.

This was a central objective for our study – quantifying what happens to our clients’ FICO® Scores as they move through the debt settlement journey. A picture is worth a thousand words, and the graph below illustrates what happens to FICO® Scores of our FDR Graduates as they go through debt settlement.

Figure 1 portrays FICO® Score distribution for FDR Graduates through box plots over time. The line within the box corresponds to the median FICO® Score. The edges of the box correspond to the 25th and 75th percentile. The median FICO® Score at time of enrollment for FDR Graduates is in the mid 600’s. The median FICO® Score 45 months later has essentially recovered from their initial starting point.

The short-term impact of debt settlement to a consumer’s FICO® Score is substantial. The median FICO® Score drops by approximately 150 points within the first six months. This reduction is associated with FICO® Score inputs focused on recency of delinquency, frequency of delinquency, and severity of delinquency. Large drops can occur when enrolled accounts become more delinquent. Additionally, as the debt charges off, the severity of the delinquency influences the magnitude of the score drop. Lastly, the number of accounts included in the settlement program can influence the score drop, as the FICO® Score measures the frequency of delinquencies on the credit profile.

One of the most commonly cited misconceptions about debt settlement is that it has a long-lasting and negative impact on a consumer’s FICO® Score. After bottoming out at six months, our study showed a steady rehabilitation in the FICO® Score. Initially, the improvement is primarily driven by the aging of the delinquencies. Delinquency information will stay on the credit report for seven years, so the charged-off debt will still be present and factored into the score. But over time, the historical delinquencies age and gradually have less influence on the FICO® Score. Over a longer period of time, the rehabilitation will be influenced by reduced debt loads. On average, 45 months after enrollment, the median FICO® Score for FDR Graduates has fully recovered to its initial starting point.

Figure 1 above illustrates what happens after enrollment. What is even more powerful is what happens after graduation. Figure 2 below shows that after graduation, FICO® Score recovery continues in the months and years immediately after the program. About two and a half years after the program, the median FICO® Score for FDR Graduates in our study essentially 680. This marks a return to the financial mainstream, a significant milestone in the credit rehabilitation for the consumer.

Figure 2FICO Figure 2

Figure 2 portrays FICO® Score distribution through box plots over time. The line within the box corresponds to the median FICO® Score. The edges of the box correspond to the 25th and 75th percentile. The median FICO® Score at time of graduation is 647. Debt settlement has the potential to put the consumer on better financial footing and facilitates robust FICO® Score recovery. The median FICO® Score 30 months after graduation is nearly 680—representing a return to the financial mainstream.

The findings on how debt settlement impacts credit scores are powerful, but they remain the tip of the iceberg. Though credit scores are powerful, debt loads are more fundamental. In my next post, we’ll do a deeper dive into how settlements and FICO® Scores are correlated in the settlement journey.

Freddie Huynh is Vice President of Data Optimization for Freedom Debt Relief where he is responsible for identifying new and better ways to use data to enhance the debt settlement business. Previously, he spent 3.5 years at Freedom Financial Asset Management re-architecting the credit risk infrastructure to deliver some of the best returns within the marketplace lending industry. Freddie also spent 18+ years at FICO where he oversaw the development, maintenance, and analytic support for FICO® Scores and was the architect of FICO® Score 8 and FICO® Score 9. Also a financial writer and contributor, Freddie holds a B.A. in Mathematics from Claremont McKenna College and an M.S. in Operations Research from Stanford University.