Debt & Credit Help Paying Off Debt

The Complete Guide to Debt Settlement

If you can’t get on track with your debts, you may consider debt settlement, but there are factors to consider first.

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Updated Dec. 6, 2024
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Debt relief companies, including settlement companies, can help reduce your balances and put your mind at ease. But, before working with a debt settlement service, I urge you to consider the fine print and risks that may have a longstanding impact on your credit. Here’s how debt settlement works and whether or not it's right for you.

What is debt settlement and how does it work?

Debt settlement, a form of debt relief, is when a creditor agrees to accept less than what you owe them to settle the account.

If you’re having trouble repaying debt, your creditor (or the debt collection agency that has taken over the debt) may be willing to accept a lesser amount of money to remove the debt from their books.

Depending on the agreement, you might pay the settlement in a lump-sum payment or through an installment payment plan.

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You can either hire a debt settlement company to work on your behalf or handle the debt settlement yourself. Either way, here’s what happens:

  • Set money aside: If you want a lump sum settlement, you’ll need adequate funds set aside for you or the debt settlement company to make the offer.
  • Negotiate with creditors: Either you or your counselor will negotiate with creditors to come up with a settlement. This step could take some back and forth between parties, and takes some persistence on your part, since not all creditors will settle on the first try.
  • Ask for a written agreement: Don’t rely on a verbal agreement as there’s no proof of what the creditor offered. Instead, ask for a written agreement so you have the proof should the creditor not honor what they promised.
  • Follow the agreement: If your creditor accepts a settlement offer, you will start making payments to satisfy your end of the deal. Creditors often settle for 40%-80% of the amount owed, but it varies by creditor and can be more or less.

Let's look at an example using a 40% settlement amount. If the total debt on your credit card is $15,000, you could end up paying somewhere around $6,000. However, if you use a debt settlement company, you’ll also pay their fees.

Once you settle the debt, the creditor should remove the account balance from your credit report. The report should say that you settled with the credit card company for an agreed amount.

Keep in mind, though, that according to the Federal Trade Commission (FTC), debt settlement programs may require you to deposit your money into a savings account for 36 months or more until a settlement is reached. This can have a significant negative impact on your credit score, which is why handling the negotiations yourself may be a better option.

Warning
Creditors aren’t always willing to accept a settlement offer, and financial risks are involved even if the creditor agrees to a settlement plan.

How debt settlement programs work

A debt settlement program is offered by a for-profit business called a debt settlement company or debt relief company. Essentially, these businesses work with your creditors to negotiate a deal allowing you to pay off (settle) your debt for less than the total amount. Notice, I said they charge a fee, so you pay money to save money.

However, if you owe multiple creditors and a debt settlement company negotiates a settlement with all of them, you will only need to make a single monthly payment to the company that negotiated on your behalf to fulfill the settlement terms.

Eliminating your debt is often a win-win scenario for all parties — you’re no longer on the hook for the full amount of your balance, and the debt collector also gets some money.

Best debt relief companies at-a-glance

I urge you to carefully research any debt relief companies you consider as this is an industry fraught with scams.

Two reputable companies are the National Debt Relief and Freedom Debt Relief companies. Each company offers slightly different debt relief solutions, but both offer free consultations and debt counselors to help you create a plan that works for you. They also work on a similar fee structure and have the same minimum debt balance requirements for using their services.

Freedom Debt Relief

Freedom Debt Relief

National Debt Relief

National Debt Relief

Minimum debt $7,500 $7,500
Program length 24-48 months 24-48 months
Fees 15-25% of total enrolled debt 15-25% of total enrolled debt
Availability Approximately 38 states 42 states
Visit Freedom Debt Relief Visit National Debt Relief

Should you settle your debt or pay it in full?

It’s always best to pay your debt in full, if you can. Even if you get a settlement agreement from the creditor, your account will show “settled for less than the full amount” or “settled as agreed.”

While this puts you right with your original creditors, it shows potential lenders that you paid less to your lenders than you originally agreed. This could have a negative impact on your credit score and ability to borrow in the future.

On the other hand, any debt account balances you completely pay off will be marked "paid in full" on your credit report. This signals to potential future lenders that you have a history of paying off every dollar you borrow and could help improve your credit score.

What types of debt are eligible for settlement?

You may not be able to settle every type of debt you have. It depends whether you have secured or unsecured debt.

Unsecured debt is the type of consumer debt eligible for debt settlement. Secured loans are already backed by property, such as your car or house. If you don’t make your payments on secured loans, the lender can repossess the collateral and sell it, leaving them with no incentive to negotiate with you.

Here are examples of debt you may be able to settle:

Pros and cons of debt settlement

Settling debts has its pros and cons. Here’s what to consider before deciding how to proceed.

Pros
  • Avoid bankruptcy: A settlement may help you avoid filing for bankruptcy. Also, settling debt means you could get creditors off your back and stop all those overwhelming collection calls. Without debt causing financial stress, you could have more wiggle room to work toward other goals, such as growing your savings account.
  • You can make arrangements yourself: You may be able to negotiate with your lenders and maybe even arrange your debt settlement plan without defaulting on the debt. This strategy will save you fees to a settlement company and help preserve your credit history because you won’t have any missed payments.
  • Better for your credit score than defaulting: According to Experian, having a debt listed as settled still isn’t great for your credit score, but it may have less of an impact than not paying at all. A debt settlement could do even less damage to your credit if you can convince the creditor to list your account as paid in full instead of settled.
Cons
  • No guarantees: There’s no guarantee a creditor will negotiate a settlement just because you sign up with a debt settlement company or negotiate yourself. You could find yourself with months (or years) worth of late fees and interest on your accounts and no settlement to show for it.
  • You could face legal action: Your creditors could file a lawsuit instead of offering you a settlement on your outstanding debt, putting you in a legal bind.
  • It may negatively impact your credit: Long-term non-payment can wreak havoc on your credit history, especially if you start the program with decent credit.
  • It's not free: If you work with a debt settlement company, it isn’t free. Companies typically charge fees equal to a percentage of the settled debt. These fees come due once they reach a settlement agreement.
  • You may still owe taxes on your debt: After the settlement, you’re not entirely in the clear because Uncle Sam may want a cut of what you didn’t pay. That forgiven debt balance may be considered taxable income, resulting in a debt settlement tax bill.
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National Debt Relief Benefits

  • No upfront fees2
  • One-on-one evaluation with a Certified Debt Specialist
  • For people with $30,000 in unsecured debts and up
Visit National Debt Relief
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Freedom Debt Relief Benefits

  • Recommended Minimum debt: $15,000
  • Has resolved over $17 billion in debt
  • Affordable program with one low monthly deposit
  • No upfront costs or hidden fees
  • May resolve unsecured debt in as little as 24-48 months1
Check eligibility from Freedom Debt Relief

How does debt settlement affect your credit?

Debt settlement can have a drastic impact on your credit score. Here’s what to expect:

Lower credit utilization

On the bright side, getting rid of high credit card account balances can reduce your credit utilization ratio, which could help your score. Your credit utilization ratio accounts for 30% of your FICO Score calculation.

However, a lower credit utilization may or may not undo the damage done by missing payments ahead of a settlement. That’s because payment history accounts for 35% of your FICO score calculation.

Missed payments hurt your credit score

The degree to which missed payments impact your score depends on your finances and history. According to data from the leading credit bureaus, missing payments do more harm to your score the higher your credit score.

For instance, someone with good credit (a FICO Score of 710) could lose as many as 180 points if a payment is 90 days late. Meanwhile, someone with a FICO Score of 607 might lose 47 points when a payment is 90 days late.

If your credit is already less-than-stellar, the benefits of settling debt could be worth the credit hit because you can work on rebuilding with a clean slate.

How to choose a debt settlement company

If you decide to go the settlement route, here’s how to pick the best debt settlement company for you:

  • Compare fees: Shop around with multiple companies to compare prices and terms. Opt for a company that doesn't charge upfront fees.
  • Look at the company’s track record: Check the Better Business Bureau to review company ratings and search the Consumer Financial Protection Bureau database for complaints. The FTC also recommends checking with your state attorney general’s office to see whether complaints have been filed against the company.
  • Read customer reviews: See what people are saying about the company and its customer service, but remember to look at the big picture.
  • Ask questions: Check each company's website or call and ask about their debt settlement process, including how long the debt negotiation process typically takes.

National Debt Relief vs. Freedom Debt Relief

National Debt Relief Freedom Debt Relief
Minimum debt $7,500 $7,500
Types of debt
  • Credit card debt
  • Payday loans
  • Store credit cards
  • Unsecured debt (including medical debt and personal loans)
  • Private student loans
  • Credit card debt
  • Payday loans
  • Store credit cards
  • Unsecured debt (including medical bills and personal loans)
  • Private student loans
Program length 24-48 months 24-48 months
Fees 15%-25% of the amount of your total enrolled debt 15%-25% of the amount of your total enrolled debt
Availability 42 states Approximately 38 states
Accreditation AFCC, IAPDA AFCC, IAPDA
Best for... Clients looking for top-notch customer service Clients with hefty debt balances looking for affordable debt relief
Visit National Debt Relief Visit Freedom Debt Relief

How to avoid debt settlement scams

Unfortunately, the debt relief industry is known for scams. Companies may try to exploit your financial hopelessness and fear, so don’t make rash decisions in desperation.

The scams often involve promises that settlement companies can't guarantee.

For example, they can't:

  • Guarantee that your creditor will be open to negotiating or guarantee to erase a specific percentage of your balance
  • State they can make your debt disappear or stop litigation if you don’t pay your debt

The FTC also warns against doing business with settlement companies that charge money upfront.

The debt settlement company should disclose the fees, how long the process will take, how much you need to save for the settlement, and the risks involved if you don’t make debt payments.

If a debt settlement company sounds too good to be true, it's a sign that it may be a scam. If you’re the victim of a debt settlement scam, you can file a complaint with your state attorney general’s office.

Alternatives to debt settlement

I encourage you to exhaust all other options before considering debt settlement. Here are some alternatives.

Negotiate yourself

Instead of paying a debt settlement company a fee for the service, you can try to negotiate with creditors on your own.

If you’re going through financial hardship for an unavoidable reason, creditors may be willing to establish a payment arrangement so you don’t default.

Creditors may prefer to speak with you and, in some cases, refuse to speak with settlement companies. Learning how to settle credit card debt yourself can often be as easy as picking up the phone.

Use a debt consolidation loan

If you’re juggling many payments to different creditors, you may be able to consolidate your debt with a debt consolidation loan. This will combine all your debt under one new loan for more manageable repayment.

Debt consolidation loans are often installment loans with a fixed interest rate and repayment term and you should compare debt settlement and debt consolidation before deciding.

Consider a balance transfer credit card

Some credit cards offer new cardholders a 0% APR balance transfer special where you pay no interest on transferred debt during an introductory term. If approved, you could have over a year of interest-free time to repay your debt.

For instance, the Citi Double Cash® Card offers a 0% intro APR on balance transfers for 18 months (then 18.49% - 28.49% (Variable) APR).

Check out this list of the best balance transfer cards if you're interested in comparing cards.

Try credit counseling

A nonprofit credit counseling agency may help you with a debt management plan so you can tackle your outstanding balance.

A credit counselor provides guidance and support for consumer credit, including reviewing your finances and negotiating with creditors to secure lower interest rates and fees. You make one payment to the counseling agency, which disburses it to your creditors.

Enrolling in this kind of debt repayment plan won’t hurt your credit score, but credit counseling companies typically charge an upfront fee and monthly fees.

According to the National Foundation for Credit Counseling, the cost should be around $50 or less upfront and $25 per month. This could be much less than paying a debt settlement company and the IRS in taxes owed on the settled debt.

Speak with an attorney about bankruptcy

If you’re at a point where you don’t have enough cash to spare to save for a settlement and your debt payments are not manageable, you might consider the bankruptcy pros and cons.

A bankruptcy attorney can discuss options with you, including whether you qualify for Chapter 7 bankruptcy or Chapter 13 bankruptcy.

FAQs

Is it bad to take a settlement on debt?

No. It’s not bad to settle debt, but it can affect your credit. Having an account listed as settled is a negative record on your credit history that can impact your ability to qualify for future loans.

Sometimes debt settlement companies will tell you to deposit your monthly payment into a separate account instead of paying your creditors. But if you don’t pay your bills, a creditor can file a lawsuit against you.

If the debt settlement company isn’t able to negotiate your debt, you could end up owing more than you did before working with the company because of late fees and penalty interest.

What percentage of a debt is typically accepted in a settlement?

A study from the American Fair Credit Council shows that debt accounts settle for about 33% less on average than what’s owed when fees are factored in. The amount varies depending on the settlement reached.

How long does it take to improve your credit score after debt settlement?

Negative account records, such as late payments or debt settlements, typically stay on your credit report for up to seven years. However, it can take as little as six months to two years before you see improvements in your credit score after you settle your debt.

As time goes by, the negative impact of late payments and/or settlements will fade as you build a new, positive credit history by paying your bills on time and reducing your debt.

What is the difference between debt relief and debt settlement?

Debt settlement is a form of debt relief. There are, in fact, a variety of debt relief options. Debt relief is an umbrella term used to describe different services that help people get out of debt.

An organization that provides debt relief programs may offer credit counseling, debt repayment plans, debt settlement services, and more. Speaking with a debt relief company may help you learn more about all your possible options.

Can I get a credit card after debt settlement?

Your ability to get a credit card after a settlement depends on how poor your credit was prior to the settlement. It can take up to 24 months for your credit score to improve once you've settled your debt. Many borrowers may have to wait years before they can get accepted for a credit card.

Bottom line

Working with a debt settlement company could be an option to consider if you’ve exhausted other repayment solutions. I encourage you to look at all options to avoid debt settlement. If you decide it’s the only option, be sure you understand the risks of hiring a debt settlement company. If the settlement company can’t reach an agreement with your creditors, you could end up with a much higher unpaid debt balance and in court for the amount you owe.

4.7
info

National Debt Relief Benefits

  • No upfront fees2
  • One-on-one evaluation with a Certified Debt Specialist
  • For people with $30,000 in unsecured debts and up
Visit National Debt Relief

Author Details

Taylor Medine

Taylor Medine is a freelance writer who's covered all things personal finance for the last seven years. She enjoys writing financial product reviews and guides on budgeting, saving, repaying debt, and building credit.

Author Details

Samantha Hawrylack

Samantha Hawrylack is a writer with more than five years of experience. Her work has been published in Newsweek, MarketWatch, USA Today, Rocket Mortgage, BiggerPockets, Crediful, and many more. She holds a Bachelor of Science in Finance and a Master of Business Administration from West Chester University of Pennsylvania, and she was previously a brokerage investment professional with Series 7 and 63 licenses at Vanguard.