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Debt settlement FAQ

How Debt Settlement Affects Your Credit Score

Many myths have been circulated on how debt settlement program actually impacts a consumer's credit score. However, the following will give you a clearer understanding of the facts:

The Fair Credit Reporting Act is a federal law that regulates the collection, dissemination, and use of consumer credit information. It also controls how the major credit reporting bureaus, Experian, TransUnion, and Equifax report consumer credit data to creditors, employers, and credit data buyers.

Under the act, all credit bureaus are required to report all derogatory ("negative") credit items on your consumer credit file for a maximum of 7 years. The exception to this requirement is a bankruptcy or lien, which may be reported for 10 years. The credit bureaus must also report all positive credit items on your consumer credit file indefinitely.

The meaning of your FICO score:
All credit bureaus also adhere to the FICO consumer credit scoring model developed by Fair Isaac Corporation. This model comprises of a series of credit scores that are used by lenders to issue consumer credit. The scores can range between 300 and 850. The higher the score, the lower your credit risk will be. A score above 720 classifies you with "perfect" credit. A score of 660-720 makes you an "acceptable credit" risk. A score of 620-660, makes you an "uncertain" credit risk. And a score below 620 makes you a "high" credit risk, which can cause you to be frequently turned down for credit.

The top three credit bureaus assign a different name to the FICO score. Equifax uses the BEACON Score. Experian uses the Experian/Fair Isaac Risk Model, and TransUnion uses the EMPIRICA Score. However, all scores are based on Fair Isaac Corporation's the credit scoring model.

The FICO score calculation is based on the following five credit score categories:

FICO Score

What a debt settlement program does to your credit score:
Enrollment in a debt settlement program can affect two FICO score categories - Payment History, which represents 35% of your credit score and Amounts Owed, which represents 30% of your credit score.

In the initial stage of the debt settlement process, you can lose points in the Payment History category. If you decide to defer payments in order to save funds to reach a settlement, creditors can report "late payments" to the credit bureaus. As a result, your credit can decline. Keep in mind that prior to joining debt settlement programs many people already caused damage to their credit. This happens from having collection accounts or high credit balances.

The good news is that the debt elimination later achieved through a debt settlement program also increase points in the Amounts Owed category, thereby improving your credit score. The Amounts Owed category includes how much you owe, the number of accounts you have with balances, and how much of your available credit you have used. Combined, these factors make up your debt-to-credit ratio.

Since the debt-to-credit-ratio makes up one third of your credit score, it is of paramount importance in qualifying for additional credit. If your credit balance is close to your credit limit, you have a high debt-to-credit ratio. However, to qualify for the best loan terms, your credit balance must be at 30% of your credit limit. If it's at 50% or more of your credit limit, banks will see you as a "high" credit risk. Even if you have a good credit score, they will see that you owe more than you can reasonably afford to pay.

Having a high debt-to-credit ratio, the beauty of being enrolled in a debt settlement program is that you can pay off your debt and bring high credit balances to a zero. And lowering your debt-to-credit ratio in turn improves your credit score.

Your credit score continues improving:
Upon reaching a settlement, your debt can be reported as "settled: paid for less" or "settled: paid in full" which can result as a negative credit item. However, this isn't as bad as bankruptcy. Plus, in addition to improving your debt-to-credit ratio, your credit continues improving. According to Fair Isaac Corporation, most of the calculation of the consumer credit score is based on recent credit history. In the most recent two-year window of your credit history, items on your credit file are weighted more heavily. This means that as long as you maintain a good two-year payment history, older derogatory items will have less significance to your overall credit score.

About Debt Free League:

The complete debt settlement service provider is pioneer of the National Debt Relief Stimulus Plan. The company employs in-house debt negotiation specialists to help people in financial hardships negotiate settlements of personal, medical, and business debts. The average client savings is 50 percent. The company is also affiliated with Libre de Deudas, which services the Hispanic community. Free debt settlement phone consultations are available by calling 800.213.9968.

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