Debt Settlement

Debt settlement involves negotiating with your creditors to pay a lump sum settlement that’s less than the debt you owe. You can try to settle debt yourself or hire a professional debt settlement firm to negotiate for you. A settlement can help you get out of debt, but it will damage your credit score.

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    Jennifer Schell

    Jennifer Schell

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    Jennifer Schell is a professional writer focused on demystifying annuities and other financial topics including banking, financial advising and insurance. She is proud to be a member of the National Association for Fixed Annuities (NAFA) as well as the National Association of Insurance and Financial Advisors (NAIFA).

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  • Updated: April 27, 2023
  • 8 min read time
  • This page features 13 Cited Research Articles
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What Is Debt Settlement?

Debt settlement is the process of negotiating with creditors to settle debt. Usually, a person with a lot of debt will pay a debt settlement company to help them negotiate with their creditors. The end goal of this type of debt relief is to reduce the amount the person owes so they can eventually get out of debt completely.

How Does Debt Settlement Work?

When you choose to work with a debt settlement firm, the firm will negotiate with your creditors on your behalf. Once a deal is reached, your total debt will be reduced, but you will have to pay it back in a lump sum instead of monthly installments.

To complete the settlement, you’ll make payments to the settlement firm, who will then pay your creditors. The company may negotiate one of two settlement options. They will either make one lump sum payment to the creditor or negotiate a term settlement to make multiple payments over time.

Who Qualifies For Debt Settlement?

Reaching a settlement for debts owed is typically a last resort for people with insurmountable debt. If you’ve fallen behind on payments or if you’re at risk of going bankrupt because the debt is just too high, debt settlement might be your best option.

Your creditors may be more amenable to settling for less than they’re owed if it seems that their other options are to pursue legal action or write off the debt as a loss. As such, debt settlement is probably not a good option if you’re still making payments on your debt.

Debt settlement is most commonly used by people who need to pay down excessive credit card debt. However, some settlement firms will also extend their services to other types of debt, such as medical debt or back taxes.

Not all types of debt qualify for settlement. Secured loans such as mortgages and auto loans, as well as certain other debts including child support, alimony and student loans cannot be settled for less than the amount owed.

What Happens to My Credit After Debt Settlement?

Unfortunately, pursuing debt settlement can have a negative impact on your credit score for a few reasons. 

To start, debt settlement requires you to stop paying your creditors. Making payments is the biggest factor to calculating your credit score, so withholding payments will result in a drop in your score.

If you’re not paying your creditors, they might choose to sell your debt to a debt collection agency. These agencies document negative entries on your credit report that can remain on your report for years.

Another element of credit score calculation is paying debts in full. When you settle your debt, you won’t pay the full amount that you owe. This can also cause your score to drop.

Negative credit information, such as missed payments or a settlement, can stay on your credit report for up to seven years. A poor credit score can make it more difficult for you to get credit in the future. Be sure you fully understand the consequences debt settlement can have on your credit before you choose to settle your debt.

Pros and Cons of Debt Settlement

Debt settlement can be a lifeline for people who feel they can never be debt free. But settling debt can have serious consequences for your financial future, and it’s not a decision to be made lightly. Before you decide to pursue debt settlement, you should consider the pros and cons.

Debt Settlement Pros and Cons


  • Pay less than you owe
  • Avoid bankruptcy
  • Get out of debt faster


  • Creditors may sue for repayment
  • Must pay taxes on forgiven debt
  • Credit will likely be damaged

Source: Pentagon Federal Credit Union

Is Debt Settlement a Good Idea?

Reviews for debt settlement are mixed. For some people, getting out of the debts they thought they could never escape is worth the expensive fees and severe damage to their credit. Others consider debt settlement a costly mistake.

At its best, debt settlement can resolve your debt for much less than you owe. The best debt settlements can result in paying only a quarter of what you owe in a lump sum. This is not typical, however; the average debt settlement amounts to 48% of the total amount owed.

Debt settlement works best if your debts have already been sold to third-party collectors. Creditors usually want to get back as much of what they are owed as possible, so your settlement might be much higher if the debt is still with the original creditor. Once the creditor has sold the debt to a collection agency, you could reach a settlement for a much lower amount.

There are some instances when debt settlement may not be right for you. You may want to look for another option if: 

  • Your debt is still with the original creditor. 
  • You have the ability to pay back the debt.
  • You don’t want to risk the damage to your credit score.

Debt Settlement Companies

The success you’ll have with debt settlement comes down to the debt settlement company you choose. Some settlement firms are professionals who can help you reach a settlement quickly and fairly, while others might make unrealistic promises they fail to deliver on.

A debt settlement company will usually charge based on a percentage of the debt you’re trying to settle or a percentage of how much you save through the settlement. The percentage generally falls between 15% and 25% of the debt enrolled in the settlement program.

For example, if you use a debt settlement company to settle $40,000 in debt, or you reach a settlement to only pay $40,000, you could owe up to $10,000 in fees to the settlement firm.

You Should Know

Debt relief companies cannot legally charge you fees before your debt is settled.

When researching debt settlement companies, watch out for signs that a firm might be less than trustworthy. For example, if the firm wants to charge you before your debt has been settled, you shouldn’t do business with them. A good debt settlement professional should not:

  • Guarantee that they can wipe out all your debt
  • Tell you about a “new government program” that can forgive your debt
  • Promise that your unsecured debt can be paid off for “pennies on the dollar”
  • Ask you to stop communicating with your creditors

Depending on your circumstances, you may choose to instead seek the counsel of a debt settlement attorney. Attorneys are legal experts, so if a creditor decides to sue you to collect your debt, a debt settlement attorney can advise you on how to proceed or represent you in court.

Can You Negotiate Debt Settlement Yourself?

Debt settlement does not require the services of a third-party firm. You do have the option to negotiate with creditors yourself.

The “do-it-yourself” approach to debt settlement can be a less expensive way to settle debt because you won’t have to pay another company to negotiate for you. However, creditors may be less willing to accept a DIY settlement. The creditor may also hire a third party to represent themselves, such as a law firm or collection agency. 

While it may be more affordable to try to settle your debt yourself, DIY settlements come with all the same consequences for your credit, and you may be less likely to negotiate a fair settlement. 

Alternatives to Debt Settlement

Debt settlement is not a process to be undertaken lightly. Before you go through with settling your debt, you should consider alternative ways to help resolve your debt issues.

Debt consolidation can be a solid alternative to debt settlement. When you consolidate your debts, you combine all your outstanding debt into one loan. These loans may have more favorable terms, like a lower interest rate or lower monthly payment.

Balance transfer credit cards are one form of debt consolidation. These types of credit cards usually have an introductory interest rate that’s low or even zero. With a balance transfer credit card, you can make a lot of progress on paying off debt without interest piling up right away.

If you feel trapped by debt and aren’t sure the best way to deal with it, talking to a credit counselor may help. Credit counseling is usually offered by nonprofit organizations, so it can be more affordable than debt settlement. A credit counselor cannot reduce the amount of debt you owe, but they can advise you on how best to manage your debt and may be able to help you negotiate your monthly payments.

Bankruptcy should always be a last resort because it can stay on your credit report for up to 10 years. Bankruptcy requires you to liquidate or sell off your assets to pay your debt. Before you decide to file for bankruptcy, you should consider all other debt relief options, including debt settlement.

Frequently Asked Questions About Debt Settlement

Is it better to settle or pay my debt in full?

In general, it’s always best to pay your debt in full, even if it takes a long time. The impact of debt settlement on your credit can be severe, and it should only be considered if other debt relief options have been exhausted. 

What happens during debt settlement?

During debt settlement, you’ll work with a settlement firm to negotiate with your creditors. If the company can negotiate a settlement, you’ll pay off your debt in one lump sum that’s less than you owe.

What is the Credit Card Debt Forgiveness Act of 2020?

Some debt forgiveness scams will cite non-existent laws such as the “Credit Card Debt Forgiveness Act” to convince consumers that they can have their credit card debt forgiven. The only way to have credit card debt partially forgiven is through debt settlement.

Please seek the advice of a qualified professional before making financial decisions.
Last Modified: April 27, 2023

13 Cited Research Articles writers adhere to strict sourcing guidelines and use only credible sources of information, including authoritative financial publications, academic organizations, peer-reviewed journals, highly regarded nonprofit organizations, government reports, court records and interviews with qualified experts. You can read more about our commitment to accuracy, fairness and transparency in our editorial guidelines.

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