When debt piles up it can quickly become overwhelming. And if you can’t increase your income to meet the monthly payments on your debt, you can easily end up facing a number that seems impossible to ever pay down or pay off. When you feel you’ve reached your limit with debt, debt settlement may be an option that can help. However, it has some pretty intense consequences for your credit score that should be considered before moving forward.

How debt settlement can impact your credit score

Going through with debt settlement will have a negative effect on your credit score. According to former FICO’s consumer operations manager Barry Paperno, debt settlement is considered negative by the scoring model “to the same extent as a charge-off or an account included in bankruptcy or repossession or something of that nature in which the lender took a loss on the debt.”

For starters, when you begin the process of debt settlement, you will be encouraged by your debt settlement representative to stop paying your monthly payments to your creditors. Payment history makes up 35 percent of your credit score total. When you stop making payments, your credit score drops.

Another consequence of not making payments is the effect it has on your credit utilization. Credit utilization makes up 30 percent of your credit score total, and is determined by looking at your ratio of debt to available credit. Ideal credit utilization is between 10 and 30 percent of your total available credit. However, if you are carrying an excessive balance due to non-payment and late fees, your credit utilization will be well over that. According to debt.org, when going through debt settlement you can expect to see your credit score decrease by at least 100-125 points. To quickly determine your current ratio, check out Bankrate’s credit utilization ratio calculator.

You can also expect to see the months of missed payments show up on your credit report as delinquencies. Delinquencies stay on your credit report for seven years from the first date a payment was missed. This mark on your credit report will make it difficult for you to get a loan or credit in the future—settling debt won’t hide the record of missed payments.

How debt settlement works

Debt settlement involves negotiating with your creditors to get out of debt. Rather than paying the full amount of money that you owe, you work with a lender to settle for less than the full amount.

Settlement doesn’t come into play until you’ve fallen behind on your payments to a serious extent. You’ll need to have missed multiple monthly payments or even had your bills go to collections before most lenders will consider it.

It’s possible to settle your debt on your own, going to lenders and negotiating a payment that will settle your unpaid debts and fees. However, many people opt to work with a debt settlement company. These businesses specialize in negotiating with creditors to help you settle.

The danger of working with a debt settlement company is that they can charge fees. That means you may not save much money in the long run. The industry is also home to less than savory actors who may try to take advantage of the financially desperate.

Once you or the company you hire has negotiated with your creditors, you’ll make your payment or get started on a payment plan to settle your debts. Once you’ve made the payment the lender will write off the remainder of your debt and you’ll no longer owe money. However, your credit score will be significantly damaged by the process.

All in all, it can take years to complete the settlement process and even longer to rebuild your credit.

Which debts you should settle

If you decide to pursue debt settlement, you have to choose the debts that you wish to settle.

To start off, you have little to no chance of settling secured debt or student loan debt. For secured loans, the lender can simply take possession of the collateral that you’ve offered. Student loans are notoriously difficult to discharge in bankruptcy, so lenders have little incentive to take less than the full amount owed.

That leaves unsecured debt. Try to settle the debts that will be most costly to repay in full, such as those that have the highest interest rates or penalty fees.

How to lessen the blow of debt settlement

Debt settlement is a difficult and risky process, but there are things you can do to soften the blow to your credit score. To begin with, you can try to take care of smaller debts on your own or through a debt management organization. Focus your debt settlement on older debt that is simply out of your reach.

You can’t begin a debt settlement until your account is delinquent, but you can time your settlement to work in your favor once you’ve reached that point. Ideally, you want to negotiate your settlement with your credit card company. This means planning to begin your negotiations while your debt is still with your original lender. This way you can avoid a charge-off, which typically occurs after 180 days of non-payment.

As you are in negotiations with your lender for your settlement, make sure you discuss how the settlement will be reported. You want it to be reported as “paid in full” and “current”. Any other reporting may cause you issues in the future. Also make sure that the account balance for the settled account is reported as $0. And anything that is agreed upon must be in writing. This will protect you if any errors are made with the amount of the settlement or how the settlement is reported.

Make sure that during this process, you have a clear understanding of your debt settlement plan. This should include a realistic starting budget so that you will be able to pay off the settlement if it goes through. Once your settlement has gone through, it is important to make your payments on time and in full to avoid future delinquencies.

Advantages of debt settlement

Though it will tank your credit, there are a few advantages to debt settlement.

  • Get out of debt without bankruptcy. Settling debt is a way to eliminate your debts that doesn’t involve bankruptcy. That means you can avoid court proceedings and may not damage your credit quite as badly as bankruptcy would.
  • Can be self-driven. You can settle your debt without any help. Though many people choose to work with a company, there’s nothing stopping you from negotiating with your own creditors.
  • Save money. Ideally, settling your debt will help you save money in the long run, even after fees paid to a debt settlement company.
  • Stop collections calls. Settling your debt will stop debt collectors from calling you and harassing you for payment.

How to rebuild your credit after debt settlement

There’s really no way to totally avoid a negative effect on your credit score and report when you’re going through a debt settlement. However, there are some things that you can do afterward to try and build your credit back up. While different outlets report different numbers, the average amount of time to raise a credit score after a debt settlement is one to three years.

Though it may seem counterintuitive, getting a credit card is one way to help raise your credit score. You can open a secured credit card, which works in much the same way as a debit card. Your credit limit will be directly linked to the amount of money you’ve deposited on the card. The difference, however, is that making purchases (and paying them off) with a secured credit card will allow you to build up your credit score again. As you enter the world of new credit, just make sure you start small. Each time you apply for credit, whether it is a loan, mortgage, or credit card, the lender will make an inquiry into your credit. This will lower your credit score a bit, though the effect is ultimately temporary.

Another way to build your credit score is to use a boost program. The credit bureau Experian offers a free program called Experian boost which gives you credit for paying your phone and utility bills. And paying off bills not only positively affects your payment history, but helps to keep your credit utilization rate to that ideal 10 to 30 percent range. Another thing that will help to keep your credit utilization in a good place is to keep your old accounts open. You want to make sure that your available credit is higher than your recorded debt. This also allows you to keep your credit history intact.

While the aforementioned steps will help you build your credit, ultimately maintaining good credit starts with your spending habits. To keep yourself on track financially, take some time to sit down and create a budget that works for your current income and expenses. You can use Bankrate’s home budget calculator if you need some help crunching the numbers.  Once you have your budget in place, make sure you keep up with all of your monthly payments. One way to make sure your recurring bills are paid on a consistent basis is to place them on auto-payment.

The bottom line

If you’ve chosen to go through debt settlement to find relief from your debts, your credit score is going to take a hit. It will take some time to build your score back up, but it is not an impossible task. Be patient with the process, and use the tools available to you. As you continue to work towards improving your credit score, you can keep an eye on your progress by signing up for credit monitoring. Bankrate offers a free credit report and monitoring tool to help.