The Credit Report Consequences Of Debt Relief – Forbes Advisor

Debt relief can be a lifeline to help you get out from under unaffordable debt—but it can also damage your credit. So, if you’re considering a form of debt relief, you’ll want to bear in mind its effect on your credit report, where the information can stay for up to 10 years.

The three most common types of debt relief are debt settlement, debt consolidation and bankruptcy.

• Debt settlement involves negotiating with creditors to pay less than the total amount owed, potentially resulting in negative marks on your credit report.
• Debt consolidation means getting a new loan or credit card to pay off your old ones. This strategy combines all your debts into one big loan, often with better terms such as lower interest or smaller monthly payments.
• Bankruptcy is a legal process for individuals or businesses unable to repay debts. Chapter 7 liquidates assets, while Chapter 13 establishes a repayment plan. Bankruptcy can significantly and negatively affect your credit, staying on reports for seven to 10 years.

How Each Debt Relief Option Affects Credit Reports

Generally, the type of debt relief, you get determines how long the information stays on your credit report. Of the three options, debt consolidation, which involves no debt forgiveness, will likely have the least impact. In contrast, bankruptcy, which wipes out some or all of your qualifying debt, will have the longest-lasting effect.

So, choosing the right option means weighing how much relief you need versus how long it will take to disappear from your credit report.

Debt Settlement: 30 Days or More

Debt settlement programs, often provided by for-profit companies, negotiate with creditors to settle debts for a reduced lump sum. Typically, advisors suggest clients cease regular payments to creditors so that the client has more leverage during the negotiation process.

Ceasing payments to reduce overall debt can lead to late payments appearing on your credit report after 30 days. Late payments remain on credit reports for seven years before being removed.

Payment history makes up about 35% of your FICO Score. If you’re late on payments and that gets reported to the credit bureaus, it can seriously affect your score. Even if you end up in a debt settlement agreement and pay the agreed-upon amount, your report will show a history of late payments.

Daniel Cohen, founding partner of Consumer Attorneys in New York City, which specializes in credit report errors and identity theft, says that the longer your debts go unpaid, the better the deal you’ll get to settle them. And while your credit may temporarily suffer, the setback isn’t permanent.

“If you eventually pay the debt, the hit that you take initially is recoverable. So, it’s kind of like a game. If [somebody is not] expecting to get a new car or house in the near future, and they have a lot of debt and want to stop paying to get a better deal at the end, their credit would be fixable, assuming they pay [the debt] off,” Cohen says.

Debt Consolidation: Two Years

Debt consolidation is when you take out a single loan or use one credit card to pay off multiple debts. The goal of consolidating debt is to spend less on interest, paying off high-interest loans with money you borrow at a lower interest rate.

When you consolidate your debt, your credit score might drop slightly. The drop is a response to the lender’s hard inquiry when you apply for a new credit account. Also, opening that account can reduce the average age of your accounts, which can affect your score.

Hard inquiries on your credit report indicate when you’ve applied for new credit and can remain visible for up to two years. However, their impact on your credit score usually lasts just one year.

Bankruptcy: Up to 10 Years

There are several types of bankruptcies, but consumers usually file Chapter 7 or Chapter 13.

Chapter 7 bankruptcy primarily involves eliminating unsecured debts such as credit cards and medical bills. Chapter 7 usually stays on your credit report for 10 years after the filing date and is automatically removed without you needing to request it.

In contrast, Chapter 13 enables you to repay overdue secured debts such as mortgages or car loans while eliminating unsecured debts. Chapter 13 bankruptcy, also called reorganization bankruptcy, is removed from your credit reports seven years after you file for it.

“There’s a long recovery from bankruptcy on your report,” Cohen says. “But there is an eventual recovery, and it’s a fresh start for people who can no longer afford their debt.”

What’s The Best Debt Relief For Me?

Because all debt relief options have pros and cons, people will come to different conclusions when choosing the most helpful option. If your credit score is high, you can afford your monthly debt payments and your debt has high interest rates, you could save money by paying off your debt with one low-interest credit card or loan.

Some credit cards have promotional 0% APR periods, allowing borrowers to transfer their high-interest debt to the new card and pay it off more easily. This choice has the least impact on your credit score.

More aggressive forms of debt relief, like debt settlement and bankruptcy, may be suitable for consumers struggling with debt repayment. While these options have longer-term consequences on your credit report, they can also be the first step in getting control of your debt and finances.

If you’re unsure what route to take, talk with a credit counselor or money coach. They can help you budget, review expenses and track spending to reach your financial goals. Free assistance options include family support centers, non-profit credit counseling services or online resources like Military OneSource.