Does debt relief hurt your credit?

If you’re feeling overwhelmed by your debt, you’re not alone. According to Experian, the average household debt balance in 2024 was approximately $105,000. That figure included credit card debt, personal loans, car loans, student loans, and mortgages.

If you’re barely keeping up with the minimum payments on your accounts (or worse yet, falling behind), you may wonder what you can do to reduce your stress and pay off your creditors. Enter: debt relief.

This post will explore the most common debt relief options, explain how each one works, and outline the potential effects on your credit score. That way, you can take action and get on the path to debt freedom.

What is debt relief?

The term debt relief encompasses several strategies that can help you get your debt under control. Depending on the method you choose, debt relief could:

• Reduce your interest rate.
• Eliminate or reduce fees.
• Modify your repayment term.
• Roll multiple debts into a single payment.

Some strategies may even lower the total amount you owe. 

Does debt relief hurt your credit?

While the benefits of debt relief can make repayment more manageable, each approach can affect your credit score differently — sometimes for the better, sometimes for the worse. Understanding these potential impacts is key to choosing the solution best for your needs.

Debt settlement

Impact on credit: Can severely damage your score while unpaid; settled accounts are better than default, but worse than “paid in full.”

Debt settlement involves negotiating a deal with your creditor to pay less than the full balance owed. You may be able to negotiate a deal yourself, or you could hire a lawyer or debt settlement company to do it for you.

If you have a third party handle the negotiation, the process will look something like this:

• You’ll stop paying your creditors (if you haven’t already).
• You’ll pay what you can into an account that you own, but that is managed by the third party.
• The third party will attempt to negotiate a settlement once you have sufficient funds in the account.
• The third party will pay your creditor from the funds you’ve accumulated once a deal has been reached.
• The process then repeats until all of your eligible debt accounts have been settled. 

When successful, debt settlement could cut your amount due in half. However, there’s no guarantee that the third party will settle your debt on all or any of your accounts.

In addition, there are other downsides you should be aware of, including, but not limited to:

• Service fees. Debt settlement companies typically take a percentage of the settled amount as payment.
• Tax implications. The Internal Revenue Service (IRS) views forgiven debt as taxable income, potentially increasing your tax bill.
• Debt type limitations. Debt settlement only applies to unsecured debts, so you can’t use it to reduce your mortgage or auto loan balance.
• Continued collection efforts. Your creditor may try to sue you while you’re saving up money to negotiate a settlement.

Debt settlement may be the right move for you if you want to avoid declaring bankruptcy, but it could still cause severe damage to your credit score. Every month that you don’t pay your creditors while waiting to save up enough to negotiate a deal results in a negative remark on your credit report.

Plus, your credit report will indicate ‘settled’ versus ‘paid in full’, which signals to future lenders you may be a higher credit risk. 

Debt management plan

Impact on credit: Generally positive; consistent payments can improve or maintain your score.

Under a debt settlement program, you: 

• Stop paying your creditors directly.
• Pay into an account that the debt management company maintains for you.
• Allow the debt management company to pay your creditors on your behalf.

Your creditors will receive a monthly payment, and you’ll ultimately repay the full principal balance owed on your unsecured debts. Sometimes, creditors are even willing to reduce the interest and fees on your account, helping you get out of debt faster.

Generally, debt management plans are administered by non-profit credit counseling agencies that work for a nominal fee and may also help you learn budgeting skills to avoid future debt. Plus, since you make consistent, timely payments and eventually pay your debt in full, a debt management plan is largely positive for your credit score.

Debt consolidation

Impact on credit: Can improve credit if old debt is paid in full, though a new account may cause a small temporary dip.

Debt consolidation is the act of taking out a new loan with a lower interest rate to pay off other, high-interest, unsecured debt. Popular financial tools for debt consolidation include: 

• A personal loan. If you have good to excellent credit, you may qualify for a personal loan with a significantly lower interest rate than a credit card.
• A balance transfer credit card. With good to excellent credit, you may qualify for a balance transfer credit card with a 0% annual percentage rate (APR) for 12+ months.
• A home equity line of credit (HELOC). If you have sufficient equity in your home, a HELOC can offer a lower interest rate than most unsecured loans, with the flexibility to borrow as needed.
• A home equity loan. This option provides a lump sum at a fixed interest rate, making it easier to budget predictable payments.
• A home equity investment (HEI). With an HEI, you get a lump sum in exchange for a percentage of your home’s appreciation (change in value, not total home value). There are no monthly payments over a flexible 30-year term. 

There’s no one-size-fits-all with debt consolidation — the best tool will depend on your financial health, debt balances, and eligibility. Each option has its pros and cons as well. When considering debt consolidation, explore each option and talk to a financial advisor or credit counselor if needed. 

Hardship programs

Impact on credit: Helps avoid defaults, but reporting or account closures may lower your score temporarily.

If you’ve fallen on challenging financial times due to job loss, health problems, or another reason beyond your control, you could ask your creditors about any hardship or debt relief programs they offer as soon as you think you’ll miss a payment. Your creditors aren’t obligated to provide assistance, regardless of your circumstances, but they may be inclined to help if you’ve been a responsible borrower to date.

Hardship programs may temporarily (generally for a few months to a year) waive fees, freeze interest rates, or reduce monthly payments, giving you some budgetary breathing room until your financial situation improves. You may need to submit documentation proving your need for hardship assistance.

Getting approved for a creditor’s hardship program can help you avoid defaulting on your debt, which would significantly hurt your credit score. However, participation in a hardship program could hurt your score if it’s reported to the credit bureaus. 

Your creditor may also suspend the use of your account while your hardship exists or could temporarily close your account. If your credit report indicates that the account is closed, your available credit may decrease, and your credit utilization ratio may increase, both of which can lead to a drop in your score.

Bankruptcy

Impact on credit: Severe damage; stays on credit report 7–10 years, though credit can be rebuilt over time.

Since filing bankruptcy is such a drastic financial move, it’s typically considered the last resort for dealing with debt. But if none of the other options will work for your situation, it may be worth speaking with a bankruptcy attorney to see if it’s the right strategy for you. 

With Chapter 7 bankruptcy, your qualifying debt gets fully discharged, so you’re no longer responsible for paying your creditors. However, you must meet income requirements to be eligible to file. Plus, the court may force you to liquidate some of your assets to repay your creditors (though most states permit you to keep your primary residence and car).

The biggest benefit to filing Chapter 7 bankruptcy is that you can get out of debt relatively fast. However, your credit score will sustain severe damage, and the negative entry will remain on your credit report for ten years.

With Chapter 13 bankruptcy, you enter into a structured, court-ordered repayment plan to pay off your creditors in three to five years. It’s easier to qualify for than a Chapter 7 bankruptcy, and it only stays on your credit reports for seven years since your creditors receive at least some of what’s owed to them.

Frequently asked questions

What are the negative effects of debt relief?

The most significant negative effect of debt relief is the potential damage to your credit score. However, ignoring your debt will have a much more negative impact on your credit and finances than pursuing debt relief.

Is debt forgiveness bad on your credit?

Debt forgiveness can give you much-needed breathing room, but it’s not without its credit consequences. When part of your debt is forgiven — whether through settlement, a hardship agreement, or another program — your lender will usually report the account as “settled” instead of “paid in full.” This tells future lenders you didn’t repay the original balance in full, which can lower your credit score.

The drop in your score is often more noticeable in the short term, especially if missed or late payments happen before the debt is forgiven. Over time, though, the impact can fade — and having the debt resolved is still better for your credit than leaving it unpaid or going through bankruptcy.

How long does debt relief stay on your credit report?

Debt relief can stay on your credit report for years, depending on the method you use. For example, a Chapter 13 bankruptcy will stay on your report for seven years, while a Chapter 7 bankruptcy can remain for up to ten years. 

Other types of debt relief, like debt settlement, may show for around seven years from the date of your first missed payment. While these marks won’t disappear overnight, their impact on your score usually lessens over time — especially if you focus on making on-time payments and keeping your credit balances low moving forward.

The bottom line

If you have more debt than you can keep up with, you may feel like there’s no way out of your financial hole. Fortunately, there are several debt relief options available that may help. While it’s possible to see a negatively impact on your credit, doing so is far better than not paying and pretending like your debt doesn’t exist.

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