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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.

Young woman stressed about debt
Taylor Medine
Samantha Hawrylack
Michael Kurko
By Taylor Medine and Samantha Hawrylack , Edited by Michael Kurko
Updated Nov. 4, 2026
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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.
  • Get the settlement terms in writing: Before making a payment, obtain a written agreement identifying the account, total settlement amount, payment deadlines, and confirmation that completing the payments will satisfy the debt. Keep the agreement and proof of each payment.
  • 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.

According to the Federal Trade Commission (FTC), debt settlement programs may require monthly deposits into a dedicated account for 36 months or more before all your debts are settled. Missed payments and settling for less than you owe can hurt your credit, whether you negotiate yourself or hire a company.

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.

If you work with a debt settlement company, you generally make monthly deposits into a dedicated account you own. An independent account administrator uses those funds to pay creditors according to each approved settlement agreement and to pay the company's earned fees.

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.

Debt settlement programs generally focus on unsecured debt. Secured loans are backed by property, such as your car or house, which the lender may repossess or foreclose on if you stop paying. However, lenders may still negotiate payment arrangements or settle a remaining balance after selling the collateral.

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 commonly charge a percentage of the original debt enrolled in the program. Under the FTC rule for covered debt relief services, they cannot collect a settlement fee until you approve the agreement and make at least one payment to the creditor.
  • Potential tax costs: Forgiven debt could increase your tax bill. Review the reporting rules and exclusions in the next section when estimating your settlement savings.

Get Out of $30,000 or More of Credit Card Debt
National Debt Relief
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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
Get rid of $25,000 in credit card debt
Freedom 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 taxes?

Forgiven debt generally counts as taxable income in the year it is canceled, unless an exception or exclusion applies. The forgiven amount is not the amount of tax you owe.

Reporting forgiven debt

Applicable lenders generally must issue Form 1099-C for cancellations of $600 or more, but smaller amounts may still be taxable. Report taxable canceled personal debt on Schedule 1 with your federal return, even if you don't receive the form. Check any forms against your settlement records and request corrections if needed.

Qualifying for an exclusion

Debt discharged in a Title 11 bankruptcy case generally qualifies for exclusion. You may also exclude canceled debt up to the amount by which your debts exceeded the fair market value of your assets immediately before cancellation.

These exclusions generally require Form 982. A tax professional can help determine your eligibility.

Preparing for the tax bill

Keep settlement agreements, tax forms, and records supporting any exclusion. Ask a tax professional to estimate your additional tax.

If you can't pay in full, file on time, pay what you can, and consider an IRS payment plan. Interest, applicable penalties, and possible setup fees may add to your costs.

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 about 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 may 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 directly with your credit card issuer

You can contact your credit card issuer yourself to discuss repayment options. Call as soon as payments become difficult, ideally before you fall behind.

Start by reviewing your income, essential expenses, savings, and credit card balances. Determine how much you can afford to pay without falling behind on other bills. Have documents supporting your hardship ready, such as medical bills or pay stubs showing reduced income.

Explain why you're struggling, how much you can pay, and when you expect to resume regular payments. Ask whether the issuer offers either of these options:

  • Workout agreement: The issuer may lower your interest rate or adjust your monthly payment. Ask whether the agreement would also change your credit limit or other account terms.
  • Hardship program: If you're experiencing a temporary setback, such as illness or job loss, the issuer may offer reduced payments, a lower interest rate, or waived fees.

These options generally help you repay your balance rather than forgive part of it. If full repayment remains unaffordable, ask whether the issuer would consider a settlement.

Before accepting an arrangement, ask about fees, how long the terms last, what happens afterward, and how the account will be reported to credit bureaus. If the representative cannot explain your options, ask to speak with someone who handles repayment assistance.

Keep the representative's name, your reference number, and written confirmation of the terms so you can address any discrepancies later.

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% intro 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% - 28.74% (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.

Get Out of $30,000 or More of Credit Card Debt
National Debt Relief
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

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