If you're in financial hardship and it's getting difficult for you to pay your bills, try to settle your dues and get out of the crisis. A settlement is an agreement between you and your creditor/CA wherein the latter reduces your outstanding dues, making it easier for you to repay your bills.

How to settle and clear your debt

When you're in problem making your bill payments, you may talk to your creditors and explain your financial condition in detail. Use letters to communicate with the creditor and mention why you can't pay, along with what alternative plan you've thought of in order to repay your bills. If you've suffered a job loss or you're going through a family crisis or medical treatment, you may not be able to make payments in full. In such a situation, you may need to settle your dues for less than the outstanding balance on your accounts.

You can settle your dues in 2 ways, as discussed below.

1. Professional settlement services: There are debt relief companies which can help you negotiate a fair deal with your creditor or collection agency. These companies negotiate with creditors and CA and have your unpaid balance reduced by 40-60%. All you have to do is get enrolled in settlement program offered by these companies and pay a certain fee for the services they provide you with.

Settlement companies usually begin with free debt counseling wherein they'll assess your debt load and financial strength. Then they'll ask you to stop paying your creditors and divert the monthly payments into a savings account (trust account) created by the company. Since you stop paying your creditors, they can make harassing calls in order to make you pay the bill. You can divert such calls to the settlement company who'll communicate on your behalf.

When you've accumulated enough savings in the trust account, the settlement company starts negotiating with your creditors who agree to accept an amount lower than the total dues. When you settle one account, the settlement company moves on to negotiate with other creditors till you get rid of overdue accounts. For further details, read through the information on how debt settlement works.

2. Do it yourself plan: This is where you take the initiative to negotiate with creditors/CA and have your outstanding balance reduced. It is better to get a debt settlement agreement signed by your creditors or CA. This is to confirm that they've accepted the offer you've negotiated with them. Regarding how to negotiate and settle your dues with the creditor or CA, check out the article "How to settle your debts yourself".

How settlement affects credit score

While you stop making monthly payments and start saving in order to gather funds for settlement, creditors/CA will report the missed payments to the credit bureaus. As such, it will lead to negative remarks on your credit report thereby bringing down your credit score.

After you've settled your debt for less than what you owe, creditors may report your payment history to the credit bureaus. They may update your account status as "Paid as settled". If the creditor has charged off your account, which implies that your account is now in collection, then the CA may report your account status as "Paid charge-off" or "Settled charge-off" once you pay off the bill.

Whether your account status is reported as "Paid as settled", "Paid charge-off" or "Settled charge-off", each of these remarks has a negative impact on your credit. To protect your credit from getting hit, negotiate a Pay for delete agreement with the creditor or CA. With such an agreement, you can have the account deleted from your credit report once you settle and pay it off. However, if you don't get a Pay for delete agreement approved, then you'll have to try out means to repair your credit after a settlement.

How to repair credit after settlement

Here's a list of 5 things you can do in order to repair credit after you settle your dues.

1. Secured credit card: Such a credit card is easily available to those with poor credit history. The purpose of such cards is to help one rebuild credit. Know how secured cards work.
2. Gas/Store cards: These are easy to qualify for. Once you get gas/store cards, keep using them every month and paying more than the minimum payment. Do not use more than 50% of the credit line at any time. Once you're able to show a positive credit history through your gas/store cards, you can apply for a higher credit line.
3. Savings account: Open a savings account and deposit funds into it every month. Take out a small loan with the savings account as your collateral. You can even use this account in order to get a secured credit card. Once you have enough savings, you can pay for unexpected expenses without having to use a credit card.
4. On-time payments: Pay your utility bills and rent/mortgage payments on time.
5. Avoid unnecessary credit: Do not take in unnecessary credit and raise your debt to income ratio. Make sure you avoid taking out payday loans right after settlement, because in case you fail to pay it off, it'll hurt your credit even more and you'll end up in debt again.

A settlement agreement helps you to get rid of excess dues and pay as much as you can. But your credit gets tarnished while you're on your way to settle your dues. However, you can restore your credit if you're able to manage other bills in a disciplined way. In addition, you need to live within your means and avoid going after loans/credit which may get out of control and lead you into further trouble.