How Does a Debt Settlement Affect My Credit?

Many of my clients consider the trade-off of having large amounts of debt forgiven through the bankruptcy process versus settling a particular debt and avoid bankruptcy. Both processes impact your credit, but does debt settlement affect your credit the same way as bankruptcy? A Georgia bankruptcy attorney has the answer.

While filing for bankruptcy almost always improves your credit score, does the same happen when a debt is settled?

What Is Debt Settlement?

A debt settlement is a way to reduce the overall debt that you owe a particular lender. Essentially, you agree to pay a portion of your debt in exchange for a full release of the whole amount due. It also usually closes your account with that particular lender.

By arranging a debt settlement, there is no need to go through the bankruptcy process to get a “discharge” of your debts for that specific lender. 

Most debt settlements are with individual lenders. There is no way to force a lender into accepting a debt settlement (without going through bankruptcy where lenders must participate). Lenders are generally under no obligation to cut your total debt.


I have certain guidelines I use when a client wishes to try to settle a debt. First, if there are other debts, then settling one debt may not be a good idea because the other bills must still be dealt with. Although one bill may be gone, you still need a plan to address the remaining bills. Can you afford to repeatedly settle and pay lump sums of cash to creditors each month? Most clients cannot. My rule of thumb is that have if you only have one or two debts, then it may be worth the effort to try and settle them. But, if you have multiple bills, your money may be better used filing bankruptcy to deal with all bills.

Even if you only have one or two bills, the amount you owe is also a consideration. For example, you may have just one bill, but if that bill has a really high balance you may not be able to reach a settlement you can afford.

Finally, you will get the best savings by paying a lump sum to the creditor, as opposed to agreeing to a monthly repayment plan. Most creditors will settle for a lot less if you are able to pay it in one payment. Creditors may accept monthly payments, but you will likely repay a higher amount. There are some good options available so speak with an attorney before deciding on your own what to do.


A debt settlement may have a negative impact on your credit score. It depends on a variety of factors, including:

  • Your current credit score
  • The amount of debt that is being settled
  • Whether the settled debts are currently delinquent
  • The difference between the amount owed and the amount for which you have settled
  • Other conditions that affect your credit, such as your overall lines of credit that you have available

You might think that a debt settlement would improve your credit score—after all, you are taking care of a delinquent account. However, the credit scoring agencies have designed the system so that it rewards those borrowers who pay their debt obligations according to the original credit agreement. Any debt settlement is going to alter the terms of the credit arrangement. Once the account is closed with a modification in the terms, then your credit score might suffer.

Whether your credit score suffers when a debt is settled really depends on your credit score at the time you settle the debt. If your credit score is not so good, then it may actually increase your credit score because the total debt balance will be removed from your score calculation.

Although you can speak directly with your lender about settling a debt, having an experienced negotiator on your side can be a big help.


Keep in mind that when debt is discharged in bankruptcy, there is no tax consequence. But, when you settle a debt you will be taxed on the amount of debt forgiven. For example, if you settle a $10,000 credit card debt for $6,000, you are taxed on $4,000. Stated differently, you have an extra $4,000 of taxable income that you must report to the IRS. Even though you settle the credit card debt, you may still owe the IRS.

If you are considering bankruptcy or alternatives to bankruptcy, it’s a good idea to involve a Georgia bankruptcy lawyer. Our experienced attorney can help you weigh the pros and cons of each option to determine which choice is right for you. Learn more by contacting a seasoned Georgia bankruptcy attorney today.