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The Truth About Business Debt Settlement and Your Credit Score

You’re drowning in merchant cash advance debt. Repayments are crippling your cash flow, and you can’t see a way out – but you’ve heard debt settlement could damage your credit. What do you do? Throw in the towel and let the funders bleed you dry, or risk a credit score hit to save your business?The answer, as with most things in the legal world, is: it depends. Let‘s explore the nuances, so you can make an informed decision on whether settling that pesky MCA debt is worth the potential credit score impact.

Understanding Credit Scores and Business Debt

First, a quick primer: your credit score is a number calculated based on your borrowing history. It‘s used by lenders to gauge your creditworthiness – the higher the score, the lower the perceived risk of default.But here’s the kicker: business debts like merchant cash advances often don’t get reported to consumer credit bureaus. So settling that MCA may not directly impact your personal FICO score at all.However, if the funder gets litigious and wins a judgment against your business, that could show up on your consumer credit report and ding your score. We‘ll circle back to that juicy scenario later.

The Debt Settlement Process Explained

When you settle a debt, you negotiate with the creditor to pay back less than the full balance owed. The creditor agrees because they‘d rather get something than potentially nothing if you default.During settlement negotiations, your credit score is at risk in two main ways:

  1. The debt could get charged off as a bad debt, showing up as a derogatory mark on your report.
  2. If you stop making payments during negotiations, you’ll rack up delinquencies that stay on your report for 7 years.
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So while settling may allow you to pay pennies on the dollar, it could trash your score in the short-term. But does that mean you should avoid it?

Weighing the Pros and Cons of Debt Settlement

Let’s look at a hypothetical: say you owe $100,000 to a merchant cash advance company, but can negotiate it down to $30,000. Your credit will likely take a hit during the process, but:

  • You’d save $70,000 that could go towards growing your business
  • Once settled, you’d be debt-free with no more payments draining your cash flow
  • Your credit score would start rebounding once the settled debt falls off your report

On the flip side, if you don’t settle and just keep paying:

  • You’re out the full $100,000
  • Cash flow stays squeezed, limiting growth and new investment
  • But your credit score remains unscathed in the near-term

The right choice depends on your specific situation and goals. If you‘re on the brink and need breathing room ASAP, the short-term credit hit from settlement could be worth it to survive. But if you can withstand the payments, keeping your score pristine may be the priority.

When Debt Settlement Could Seriously Damage Your Credit

In some scenarios, settling debt can lead to a major, long-lasting credit score drop. Three situations where this is likelier:

  1. The Funder Litigates: If negotiations break down, the cash advance company could sue you for the remaining balance. A judgment on your credit report is a scorecrusher that could last 7+ years.
  2. You Have a Personal Guarantee: Many merchant cash advance contracts require a personal guarantee, making you personally liable if your business can’t pay. Settling this type of debt is more likely to impact your consumer credit.
  3. You Owe the IRS or State: Settling tax debts by negotiating an Offer in Compromise can result in a huge derogatory mark on your credit report. The IRS doesn’t mess around.
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If any of those scenarios apply, the risks of debt settlement may outweigh the benefits when it comes to protecting your credit score. You’d be smart to consult a professional before pulling that trigger.

Minimizing Credit Score Damage from Debt Settlement

Even if you decide to settle, you can take steps to limit the credit score fallout:

  • Try to Pay for Delete: Get the creditor to agree to remove the derogatory mark from your report in exchange for a lump sum payment. It’s an uphill battle, but worth a shot.
  • Negotiate While Staying Current: Don’t stop making at least minimum payments during negotiations. It’ll prevent delinquencies from piling up.
  • Settle One Debt at a Time: Having multiple settled debts updating at once amplifies the credit score damage. Space them out if possible.
  • Explain the Situation to Creditors: Many will consider removing settled debts from your report if you can demonstrate financial hardship. Having a solid explanation helps.

And of course, working with an experienced debt settlement attorney can tilt negotiations in your favor for a better outcome.

The Credit Score Rebound After Debt Settlement

Let’s say you bite the bullet and settle that MCA debt, taking a credit score haircut in the process. How long until your score recovers?It depends on the specific derogatories and their severity, but generally:

  • Settled debts should fall off your report after 6-7 years
  • Your score could rebound significantly within 1-2 years if you keep other accounts in good standing
  • Length of credit history and credit mix are also factors, so older consumers may see a quicker recovery

The key is continuing to practice good credit habits post-settlement. Make all other payments on time, keep credit utilization low, and avoid taking on too much new debt. Your score will thank you.

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