How Does Settling a Debt in Collections Affect Your Credit?

The ghosts (or zombies) of your unpaid debts almost always come back to haunt you, usually in the form of annoying phone calls, incessant letters, and confusing settlement offers. Once your outstanding debt is sold to a collections agency, those agents will do their best to convince you to settle your old debt with them.

A Few Words of Caution

If you do decide to work with a collector, first and foremost, you want to make sure they’re a legitimate company. There are a lot of scams out there, and if the collector is harassing you or demanding immediate payment, or they don’t accept common forms of payment, those are red flags. Also, thanks to the Fair Debt Collection Practices Act, collectors are required to send you a written notice of your debt within five days of initial contact. This is also called a debt validation letter, and most reputable collections agencies will send this before contacting you by phone.

Before you agree to anything, you also want to fully understand what you’re getting into. Many people jump into debt settlement because it seems like an easy fix. Debt settlement is tricky, though, and it may not repair your credit as much as you’d think. To be clear, for the remainder of the article, we’ll be discussing debt settlement with a collection agency, which is different from working with a debt settlement company.

What Happens When You Settle Your Debt

Paying off your debt, even some of your debt, seems like the responsible thing to do. However, credit scoring companies don’t necessarily see it that way. When you stop making payments on a debt, the original creditor sells it to a debt collector, and, as you can imagine, this negatively affects your credit.

“When you settle a debt you negotiate repayment for less than you actually owe,” says Rod Griffin, Director of Public Education for Experian. “Once a debt has been sold or transferred to collection, any payments or negotiation should be done with the collection agency. They are now the legal owner of the debt. The original account should have a status of charge off and will indicate that it has been transferred or sold to collection.”

Settling a debt is considered negative activity, but Griffin points out that it’s still better than not paying at all. “Your credit scores will suffer anytime you settle a debt and will decline even more if you don’t pay at all,” says Griffin.

When you settle your debt, the activity usually shows up on your credit report as “debt settled” or “partial payment” or “paid in settlement.” You can talk to the settlement company about the specific language they use, but the bottom line is: this is a red flag on your report. FICO doesn’t reveal how much your score will drop, exactly, and your report doesn’t indicate how much of the original debt was forgiven; it simply shows you settled. Either way, it still points to the fact that you may be a credit risk. But again, so does not paying your debt to begin with. Also keep in mind that this is likely better for your score (though we can’t say by how much) than paying nothing and waiting for the debt to drop off your record.

How Potential Lenders View Your Settled Debt

A lender might look at your attempt to repay as a good sign. Others may still see you ask a risk; it all depends on the lender. Some mortgage companies, for example, actually require borrowers to pay off old debts before closing on the loan.Again, a partially settled payment is still considered negative activity. If you want to pay the debt in full to avoid the hit to your credit, it’s best to do it before the debt is actually sold, or “charged off.” This way, the debt will show as late, but it will also show that it’s been paid in full. After it’s sold to a collections agency, though, the bulk of the damage has already been done.

“If the account has not yet been charged off, you may be able to negotiate settlement of the debt if you are unable to pay it,” Griffin says. “Settling a debt will still have a significant negative impact on your credit scores, but it may be slightly better than allowing the debt to be charged off as a loss and sent to collection before negotiating settlement.”

Other Factors to Consider

You also want to consider the statute of limitations on your debt. Most past debts remain on your credit report for seven years, so if you’re close to the time frame when the debt falls off, settling it may not make much of a difference. There’s an ethical argument to be made here, but practically, you might just be settling a debt that was about to disappear anyway.

Your credit score will take a hit when you settle, but Griffin says “just how significant the score impact depends on each individual’s unique credit history.” In other words, the hit your score takes will depend on how high it is to begin with. Generally, the higher your score, the larger of an impact negative activity has on it.

Either way, when dealing with a debt settlement company, you must get all of your terms in writing. You might even be able to negotiate the language they use to report the activity to the bureaus. Some will agree to report that you’ve satisfied the debt in general, which might be a little better than a “partial payment.” Again, it very much depends on how a lender prefers to interpret that activity. Your discretion may differ from theirs.

Beware of the Tax Hit

Another factor to consider when settling your debt is taxes. If the amount of debt that’s forgiven is more than $600, the IRS will probably mail a 1099-C “cancellation of debt” form to you. This means you’ll have to report the amount as taxable income. In short: yes, you’ll owe taxes on it.

If the forgiven amount is significant, that could mean a big bill around tax time. If that stretches your finances thin, you want to be careful that you don’t go back into debt or get behind on any other payments.

Generally, debt settlement can be complicated, and it’s not the financial cure-all that people often assume it is. Knowing how it works can help you make the best decision for your own situation.

Kristin Wong writes and makes videos about all things money. You can find her writing at Lifehacker,, and on her own personal finance blog, Brokepedia.

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24 responses to “How Does Settling a Debt in Collections Affect Your Credit?”

  • Len Wells


    I have five derogatory things in my credit files, with the oldest of the five being 4yrs and 9 months. I want to be approved for a mortgage and wanted to settle these accounts. I talked to two of the five collection accounts and I asked for something in writing from them both if I was to pay it. I was told by one that they can give me a letter stating the settlement agreement and told by the other one that would hey couldn’t give me a letter of the agreement until I payed the agreement price. The first one also stated that it will be reported as paid in full and that I could call the credit bureaus myself to have it removed, because they don’t delete them. The second one said that once I pay it that it will be deleted from my credit file. I want to get a mortgage that’s why I’m trying to clean up the few things hurting my credit but on the flip side I have 21 open accounts that are favorable, with 13 of them being student loans and the others being a car lease, and credit cards that are in good standings. What should I do?

    • Emilie Burke

      Hi Len! I would strongly suggest focusing on getting those cleaned up! You are correct to want something in writing before paying off or settling those accounts. I hope that helps!

  • Dorothy

    What happens if I called and they said that they would settled my account. Does that mean it’s paid in full or partial payment has been made. Will my credit score go up or down

    • Emilie Burke

      Hi Dorothy! As the post goes into, often times a settled account can negatively affect your credit score, depending on how it’s reported. Hope that helps!

  • Hello. Will it make a big difference in my credit score if I settle one debt or multiple debts? What I’m asking is, if it’s going to hurt my credit settling a debt should I just go ahead and settle three and get it over with?

    • Emilie Burke

      Hi Cindy! Most likely, yes, your credit score will be negatively affected by settling your debts. If you take on initial hit, though, you can rebuild your score over time, instead of having multiple hits. Hope that helps!

  • Matthew

    If your debt has already been sold and the damage is done, does it still look better as paying the debt in full? How much of a difference would it make between taking a settlement or paying in full if you are already in collections?

    Sorry if you’ve already covered some of this but didn’t see a straight answer

    • Emilie Burke

      Hi Matthew! That’s a great question. It depends on how the debt is reported (“settled” vs “paid in full”). You can usually negotiate how it’s reported even in the settling process. Hope that helps!

  • Marian

    My husband’s credit score went from 800 to 650 because he was a co-sign on our son’s car lease. The car was returned but long story short the lease termination fees (over $1,000) were passed to a collection agency. Our son paid the collection agency in full but how do we get my husbands credit score back to normal?!

  • Stephanie delacruz

    If your in collection and pay your balance in full will that look better then settling or will it stay the same since your already in collections.

    • Emilie Burke

      Hi Stephanie! There are definite benefits to your credit score for paying off an account in collections! Good luck!

  • Barbara Hecker

    I have an old cc that went to collections. Since it’s with a collection agency, is it better to pay in full or take the settlement of 1/2? This is the only negative left and my credit score has been going up, but naturally I’d rather pay 1/2 if it will not make much difference.

  • Rafael Cabrera

    If an account is already in collections, should I try to settle that amount? Also, do you recommend an attorney to speak on my behalf?

    • Emilie Burke

      Hi Rafael! A lot of times, you can do it yourself! You don’t need a lawyer. Good luck! We’re happy to help!

  • Warren L.

    I settled with a debt collector and still received a 1099 for the full amount of the debt, but I thought once it was settled, they couldn’t still charge off the full amount, as not only have the received some money but have now received a tax break on the original debt. Is that correct?

    • Emilie Burke

      Hi Warren! It depends on the agreement of the settlement you made. For example, they may have put your payment towards interest and/or fees and charged off the loan. You should check what you got in writing!

  • Is there any way you can pay off an old debt on your credit report, and have them to remove it off your credit report?

    • Emilie Burke

      Hi Renee! Usually, you can negotiate how your debt is reported in the process of paying it off. Usually they can report in a way that is more favorable, but usually they won’t totally remove it.

  • Laverne Rathert

    can a bill collector come back and make you pay more money even after you have settled within for a lesser amount on a old account

    • Emilie Burke

      Hi Laverne! If you have the settlement agreement in writing, you should not have to pay anything else. Good luck getting the situation worked out and let us know if we can help at all!

  • Viola cutler

    If your credit card gets charged off but you don’t settle instead pay it in full what will it say on your report and will your credit go up or down ?

    • Emilie Burke

      Hi Viola! Thanks for your question. As mentioned in the article, “When you settle your debt, the activity usually shows up on your credit report as ‘debt settled’ or ‘partial payment’ or ‘paid in settlement.’” Your credit score will go down if you settle a debt, but it will go down less than it would if you continued to not pay. I hope that’s helpful!