What Hurts Your Credit Score More: a Bankruptcy or Debt Settlement?

by Van Thompson, Demand Media

The stress of being in debt can make bankruptcy or debt settlement seem like steps toward freedom. Both approaches can harm your credit score, but the effects of bankruptcy are more severe and last longer. Before you consider either approach, consider talking to a financial planner or lawyer who specializes in credit and debt collection.

Why Bankruptcy Is Worse

While most negative credit items only stay on your report for seven years, a bankruptcy can stay on your report as long as 10 years. A bankruptcy eliminates your debts, even those for which you've made timely payments. Consequently, your credit history is robbed of even positive items. Because a bankruptcy makes it extremely difficult to get credit for up to a decade, it also prevents you from adding positive items to your credit report in the future.

Factors In Credit Score

Your credit score is calculated according to five factors: new applications for credit, the amount of debt you have, your payment history, how long you've had credit and the types of credit you use. A settlement may only affect one account, but it can lower your score in several categories. However, because a bankruptcy affects all your accounts and interferes with your ability to obtain new credit, it can destroy your credit score.

Settlement After Default

If you've already defaulted on a line of credit, a settlement could actually improve your credit score, depending upon the agreement you strike with the creditor. If the creditor removes the default and notes that you're paying on the account again, you might see an uptick in your credit score.

Settlement Prior To Default

If you haven't defaulted on a loan or credit card, a settlement can harm your credit much more. The reason for this is relatively simple. When you default, your credit has already taken a hit, but if you haven't yet defaulted, your credit score may be relatively high, even with lots of debt. When you opt for a settlement, it will be noted in your credit report, and this can lower your score significantly.

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About the Author

Van Thompson is an attorney and writer. A former martial arts instructor, he holds bachelor's degrees in music and computer science from Westchester University, and a juris doctor from Georgia State University. He is the recipient of numerous writing awards, including a 2009 CALI Legal Writing Award.

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