What Is Debt Settlement?
Debt settlement is a process that can get some or all of your debt forgiven. For a fee, you can attempt to settle by using a debt settlement company. You can also try to negotiate yourself for free.
- You could pay less than you owe with debt settlement, but it’s not guaranteed.
- You can attempt to settle your debt for free without the help of a debt settlement company.
- Debt settlement may be best if you have bad credit and don’t want to file for bankruptcy.
How debt settlement companies work in 5 steps
Debt settlement is a form of debt relief that can reduce how much unsecured debt you owe. This includes credit card debt, personal loan debt and medical debt.
- A debt settlement company helps you decide what unsecured debts you want to try to settle, based on their experience with the creditor. Not all creditors are willing to negotiate.
- You enroll in the program and will usually stop making payments to your creditors. Instead, you will give that money to the debt settlement company.
- The debt settlement company puts the money in a separate account, which you will have full control over. You may have to pay a monthly account maintenance fee.
- Once the account is big enough, the debt settlement company will use it to negotiate with your creditors. Between saving for a settlement and negotiations, most debt settlement programs take 12 to 48 months to complete.
- If a settlement agreement is reached, you will pay less than the amount you owe. Many debt settlement companies claim to save their clients around 15%-35% on their debt after fees. Debt settlement fees are typically 15% to 25% of the debt you enrolled.
Disclaimer: Credit outcomes vary by individual. Responsible use may help, but results aren’t guaranteed. LendingTree does not promise credit score improvement or credit approval for any product.
Compare your debt relief options
Get personalized debt relief solutions that may reduce what you owe and help you regain financial stability.
When debt settlement could make sense
Digging your way out of a mountain of debt isn’t just hard on your wallet — it can take a mental and physical toll, too. Debt settlement is generally seen as a last resort because of its cost and the negative impact it has on your credit. But for some, it can provide a path forward.
Debt settlement could be a solution if:
You don’t want to declare bankruptcy
Some people avoid bankruptcy with debt settlement programs.
Bankruptcy is a legal process that eliminates some or all of your debt. Although it’s not a decision to take lightly, bankruptcy can be a lifeline if you have no chance of affording what you owe. Still, it’s probably the most drastic thing you can do, personal-finance wise.
Further, bankruptcy is public record, and it requires a lot of paperwork. Debt settlement is not public, and it typically takes just a phone call to a company, although you should make sure the company is reputable.
Debt settlement also shows up on credit reports for a shorter amount of time than some types of bankruptcy. For instance, Chapter 7 bankruptcy takes 10 years to fall off your credit report. Settled debt generally takes seven years (the same as Chapter 13).
You aren’t a good candidate for an alternative
Debt settlement and bankruptcy shouldn’t be the only debt relief options you explore.
| Type of debt relief | What it is | Who it may be best for | Where to learn more |
|---|---|---|---|
| Debt consolidation | A way of combining many debts into one | People who can afford their debt but want a lower rate | Debt Consolidation vs. Debt Settlement |
| Credit counseling | Low-cost financial planning with a professional | People who can afford their debt with a better budget | What Is Credit Counseling? |
| Debt management plan (DMP) | A three-to-five-year plan to get out of debt (but you pay what you owe) | People who can afford their debt if they had lower rates or a longer time to pay | What Is a Debt Management Plan? |
Debt settlement risks
Enrolling in a credit card debt relief program is a serious financial decision. Below are some risks that can come with debt settlement that you should consider first.
Damaged credit score
Most people considering debt relief already have less-than-perfect credit, so a damaged credit score might not be as big a concern. Generally, the lower your score is now, the less of an impact debt settlement may have.
Still, you need to know that debt settlement will hurt your credit. You will miss payments while you work the program. Money that you’d normally give to your creditors will go to the debt settlement company, where it’ll sit in an escrow account.
Payment history makes up 35% of your FICO Score, making it the most important factor. One missed payment can cause your credit score to drop by over 100 points.
If your debt payment goes unpaid for long enough, you may end up in default on your loan or card. Debt settlement programs can take one to four years to complete.
Also, settled debt shows on your credit report for up to seven years. To lenders, settled debt is a red flag, so you might have a hard time getting a card or loan in the future.
You may end up with more debt than when you started
When you stop making credit card payments, interest and fees will continue to accrue until you settle.
Credit card interest typically compounds daily when you carry a balance from month to month. Every day, your credit issuer will calculate how much interest you owe and add it to your total balance. You’ll pay interest on your interest.
Compounding interest and late payment fees will eat away at what you saved by settling. If the company isn’t successful, you might end up worse off than before you enrolled.
Success isn’t guaranteed
Your creditors don’t have to settle. Maybe the creditor has an internal policy against settling. Perhaps you don’t have enough money in your account to get your creditor to agree. Either way, you might end up accumulating interest, fees and damaging your credit score, just with no savings.
Debt collectors can still sue you
At first, expect calls from debt collectors even if you’re in a debt settlement program. You can get them to stop calling by sending a written request, but you’ll still owe the debt.
Some debt settlement companies also offer legal assistance, sometimes for a monthly fee. That’s because you can still be sued by debt collectors after enrolling in a debt relief program.
When you enroll in a debt settlement program, the debt settlement company will likely tell you to stop paying your credit card bill (unless you already have a lump sum of money to offer as a settlement).
When debt goes unpaid for long enough, you put yourself at risk for a debt lawsuit and wage garnishment. Some companies include legal services automatically in their debt settlement programs (but not all).
Settled debt is usually considered taxable income
You typically have to pay taxes on settled debt above $600. If the IRS considers you insolvent — or, if you have more debt than what your assets are worth —, you might be able to exclude the debt. That means you would no longer be required to pay taxes on it.
Speak to a tax professional for more information.
How to make sure a debt settlement company isn’t a scam
Debt relief was largely unregulated until 2010, when the Federal Trade Commission (FTC) strengthened laws that banned deceptive debt relief practices.
Although these safeguards will hopefully stop you from falling victim to a debt settlement scam, still watch for red flags like:
- Charges settlement fees before the debt is settled (this is illegal)
- Promises specific, guaranteed results
- Mentions a government program involving credit card debt (this doesn’t exist)
- Says it can stop debt collection lawsuits or collection calls
Do these three things before signing on with a debt settlement company.
- Check if the company is accredited by the Association for Consumer Debt Relief (ACDR), which requires compliance with debt relief laws, ethical standards, transparent pricing and ongoing education.
- Read about other people’s experiences by checking the Consumer Financial Protection Bureau’s (CFPB) customer complaint database.
- Search the FTC’s legal library to see if the FTC has filed a lawsuit against the company.
Tips for DIY debt settlement
You don’t have to hire a debt settlement company to work something out with your creditors — you can negotiate yourself. Below are some tips that could help get your creditors to agree to settle.
Note that you may need to speak directly with your creditor or with a debt collector, depending on how far behind you are. Your creditor can give you more info.
- Demonstrate financial hardship. Showing your creditors that you fell behind due to a layoff, prolonged illness or other extenuating circumstance can work in your favor.
- Tell them about all the other debts you owe. If you have tax liens or have court-ordered debt like child support or alimony, let your creditors know. By law, these types of debts need to be paid first, so maybe they’d prefer getting paid now instead of later (if ever).
- Make sure your offer is high enough. It’s going to be hard to get a debt collector to settle for $500 if you owe $10,000. Offer enough money that the settlement is enticing. And always expect the debt collector or creditor to give you a counteroffer.
Check that debt: advice from an expert
We asked Matt Schulz, LendingTree chief consumer finance analyst and author of “Ask Questions, Save Money, Make More: How To Take Control of Your Financial Life,” what he thinks people should know before settling debt.
Other than the negative credit score impact, Schulz stresses the importance of making sure the debt is legitimate. “The debt could be old enough to have passed the statute of limitations for collections.”
“If you’re unaware that the statute of limitations on your debt has passed, but you make a payment or agree in writing to make a payment, it could ‘restart the clock’ on you, making that debt collectable again.”
If you’re unaware that the statute of limitations on your debt has passed, but you make a payment or agree in writing to make a payment, it could ‘restart the clock’ on you, making that debt collectable again.
In short, make sure that you’re not agreeing to pay time-barred debt.
According to the Fair Debt Collection Practices Act (FDCPA), once a debt has reached a certain age, the debt collector can’t sue you over it or garnish your wages over it. You still owe the debt, but the debt collector can no longer take legal action over it.
Read “Fair Debt Collection Practices Act: Know Your Rights” for more information.
Frequently asked questions
No, debt settlement is not the same as debt consolidation. Debt settlement is a process that can get some of your debt forgiven. A debt consolidation loan rolls multiple debts into one. How much you owe won’t change, but you’ll only have one bill instead of several.
Debt settlement companies typically charge 15% to 25% of the debt you enrolled (not what the company actually had success in settling). Most debt settlement companies also charge a monthly fee for the dedicated bank account it uses while you save up funds to offer as a settlement.
Debt settlement can work on medical bills and private student loans. On very rare occasions, the government may be willing to settle federal student loans. However, it will more than likely set you up with an income-based repayment plan instead.
Yes, creditors can still sue you if you’re in a debt settlement program. Many settlement companies have attorneys available for this reason, sometimes for an extra fee.
Debt settlement will almost certainly cause a big drop to your credit score, but it depends on what your score is now. If you already have poor credit, then the drop might not be as bad as it would be if you had good credit.
Settled debt shows on your credit report for seven years. Plus, you may miss years’ worth of credit card and other payments as you work a debt settlement program.
No matter your situation, we’ll find the best solution together. Just a few clicks (or taps) away!