Does Debt Relief Hurt Your Credit?

It's true that debt relief could impact your credit, often negatively. Your debt could also be negatively impacting your credit before you even try debt relief. The thing to focus on is that your credit scores aren't set in stone. You can repair your credit—and it will probably be a lot easier to do without debt hanging over your head.

The point of debt relief is to help you move beyond debt so you can create a better financial life, including a better credit profile. If you’re buried in debt, concentrate on that before your credit scores and reports. Good credit is easier to build after you get rid of debts and achieve more manageable finances. 

Here’s a big-picture look at how different options for debt relief can affect credit—and how to make well-informed decisions when dealing with debt. 

Disclaimer: Freedom Debt Relief is not a Credit Repair Organization and does not provide or offer services or advice to repair, modify, or improve your credit.

How Debt Relief Affects Your Credit Score

Debt relief's impact on your credit score depends on the type of debt relief you choose and the initial state of your credit. Here are a few quick facts about how debt relief affects your credit: 

• The biggest factor in credit scores is on-time payment history. Missed payments and delinquent debts could hurt your credit whether you're in a debt relief program or not. 

• If debt collectors are calling, your credit already took a hit. Debt doesn't go to collections unless it's well past due, so your credit likely has a delinquent account if you're getting collection calls.

• People with lower credit scores tend to have smaller decreases from debt relief. If you’re already struggling with missed payments, overdue debts, and other debt issues, those challenges are already being reflected by your credit score. A debt relief program might cause your score to dip a bit more, but it might not be as sharp a decrease as you expect. 

Debt relief could be a relatively small part of your negative credit history. And debt relief could be the start of a way out. Getting rid of debt is your first priority. Then you can begin to rebuild your credit.

Credit Impact by Debt Relief Option

Here are a few ways that different debt relief methods could affect your credit score. 

Debt settlement 

If you’re already behind on debt payments, working with a professional debt settlement company might not affect your credit score much. The main impact is typically from missed payments, as many people in debt settlement programs choose to stop making their debt payments while saving up for a settlement. 

Late payments could have a huge negative impact on your credit score, and they hang around for up to seven years. On the other hand, if you're already behind on payments, as is the case with many people who join a debt settlement program, then the credit score impact from missing more payments could be less severe.

Furthermore, settling debts could have less negative impact on credit scores than letting debts go delinquent until they’re charged off. After accepting a settlement offer, your creditor may mark the debt as settled or paid-settled on your credit report. That’s not as favorable as paid as agreed, but it could be better for your credit score than an unresolved delinquency.

Debt management plans

If you work with a nonprofit credit counseling agency, credit counselors work with your creditors on your behalf and set up a debt management plan (DMP). This could involve asking your creditors for lower interest rates or fee waivers. 

You still make monthly debt payments while in the DMP, so there shouldn't be damage from missed payments. However, your creditors may make a note on your credit report that you're in a DMP; this isn't calculated into your credit score, but other lenders could see it if they pull your credit report.

Additionally, some DMPs may require you to close your credit cards as part of the program. If those accounts have balances when you close them, your credit score could see a dip due to an increase in your credit utilization (how much of your credit you're using). High utilization could cause credit score damage until the balances are paid down. 

Debt consolidation 

Debt consolidation is a popular choice for credit card debt relief since it lets you combine multiple debts into a single new payment, ideally with a lower interest rate. How consolidation impacts your credit will depend a lot on your current credit history and how you use the loan.

Initially, opening a new loan could cause your credit score to lose a few points when your lender performs a hard credit inquiry to check your credit. Hard inquiries impact your score more the more you have, so keep other applications for credit to a minimum to reduce the impact.

Once you put it to use, a consolidation loan could potentially boost your credit score. Consolidating credit cards with an installment loan could lower your credit utilization ratio, which could have a positive effect on your credit. And on-time loan payments could go a long way toward helping you rebuild your credit over time.

Debt consolidation is usually an option for people who have fair to good credit. This debt relief method may not be an option for people who are already behind on bills. 

Bankruptcy 

Filing bankruptcy could help you get nearly immediate debt relief, temporarily stop debt collections, and get rid of debt in a way that’s protected by law and managed by a court. However, it may involve giving up assets or a mandatory payment plan. It's also considered a negative credit item and the impact to your score can last seven to 10 years.

Bankruptcy typically causes severe credit damage at first (though if you're already behind on your debts, you may not notice as much impact). That damage reduces over time, especially if you work diligently to rebuild positive payment history. Borrowing can be difficult after bankruptcy, but you still have options to rebuild, such as using a secured credit card.

Steps to Rebuild Credit After Debt Relief

There are no hard-and-fast guarantees for how soon you can rebuild credit after debt relief, or how much and how quickly your credit score will improve. Your credit score will be based on your own credit history and how you manage your money going forward. 

Here are a few general tips that could be helpful in rebuilding credit after debt relief. 

Start with a secured credit card 

Unsecured credit—credit without collateral, meaning nothing of value to back it up—may be hard to get if your credit has been damaged. So focus on secured products designed for credit building.

Secured credit cards let you make a cash deposit to open a credit card. Use it like a regular credit card to make necessary purchases, then pay in full before the due date each month. Over time, you could graduate to an unsecured card and get your deposit refunded.

You could also consider a credit-builder loan. These typically have you make monthly loan payments upfront, then you get the money back when you've made all the payments. These get reported as loans to the credit bureaus, so on-time payments could help you rebuild credit.

Focus on consistent on-time payments 

Payment history is the most powerful factor influencing your credit score. Keep those on-time payments coming, and you’re likely to notice improvements in your credit score. You could expect to start seeing some positive movement in your scores after about six to 12 months of on-time payments.

Avoid new debt 

Once you go through debt relief, make a financial reset. Build your budget, keep on top of your spending—and avoid new debt. Work first on stabilizing your finances and building up some cash in the bank. No need to rush. One secured credit card, paid in full each month, should be enough to help you start rebuilding your credit while you work on the rest of your finances.

Build an emergency fund

Having a well-stocked emergency fund is a simple way to avoid needing to take on unplanned debt in the future. Start with a small fund of around $1,000, then work up to three to six months' worth of expenses.

An emergency fund should live in an easy-to-access account, preferably a high-yield saving or money market account you can access quickly in an emergency. Then leave it there unless there is a genuine need, such as a sudden car repair, job loss, or medical event.

Monitor credit reports 

No matter what your credit score is, after you finish a debt relief program—and any other time of life, really—it’s good to regularly check your credit reports. Monitoring your credit reports could help you find errors, detect fraud, and watch for any changes. 

Use AnnualCreditReport.com to get government-authorized free credit reports every week from all three credit bureaus. Various credit monitoring apps and services can also help you keep an eye on your credit reports and scores. 

What Shows on Your Credit Report After Debt Settlement

If you go through debt settlement, whether you DIY negotiations with creditors or use a professional debt relief company, the settled debts will appear on your credit report. The exact impact of debt settlement on your credit score will vary based on your overall credit history and the overall picture of your personal finances. Here are a few things to keep in mind. 

Debt settlement shows up on credit reports 

You’ll typically have a record of debt settlement on your credit report. Accounts that have gone through debt settlement show up differently than paid-off or delinquent accounts. A zero balance is reported once the account is resolved. 

Your settled accounts will typically appear on your credit report as paid-settled or settled for less than full balance. The credit impact of debt settlement is typically less severe than leaving an unresolved delinquency on your credit report. 

Debt settlement stays on your credit for seven years 

This entry remains on a credit report for up to seven years from the original delinquency, which is when you first fell behind on the account. The impact it has on your credit usually lessens with time, and you could reduce it even more by building up a new positive payment history.

You can rebuild credit after debt settlement 

Getting rid of your debt can be freeing—both psychologically and financially. Without that debt hanging over your head, you can move forward on better financial footing. Build a manageable budget, dedicate yourself to paying all of your bills on time, and start rebuilding credit.

It probably won't be easy to get new credit at first, but you could build up to unsecured credit cards and favorable loan terms in a few years. By the time the settled accounts leave your credit reports, you could be in a stable financial position with a strong credit score.