What is Debt Settlement and What You Need to Know?


Americans have a total of 1.04 trillion in credit card debt, with 55% of households carrying a balance from month to month. When the typical interest rate on credit card debt is 16.46%, you, like many other families, are likely paying hundreds of dollars a month just to cover the interest payments on your outstanding credit card balances.

Just one, unexpected expense or reduction in income could spell disaster, leaving you unable to make even the minimum payments on your credit cards.

Debt Settlement, sometimes referred to as Debt Negotiation, is a type of debt relief program suitable for people with a demonstrated hardship, allows you to resolve unsecured debts while paying less than the full balance you owe. Companies providing debt settlement services offer turn-key solutions that give you all the tools required to become debt-free in as little as 24-48 months.

If you are overwhelmed with substantial amounts of unsecured debt and want to partner with a company that will work directly with creditors on your behalf, debt settlement might be your best hope to eliminate your high-interest debts at the lowest cost, in the shortest period of time, and without having to file for Bankruptcy.

Key Takeaways
  • Debt Settlement is a type of debt relief program for people who have experienced financial hardship.
  • Professional Debt Negotiators work on your behalf with your creditors to negotiate a settlement of your unsecured debts for less than you currently owe.
  • By completing a Debt Settlement program, you could become debt-free in two to four years depending on the number of accounts enrolled and the total amount of your debt.
  • Debt Settlement is a legitimate, legal debt relief option that is regulated by various state and federal agencies.
  • Debt Settlement Companies must be adhere to strict licensing and bonding requirements in the states in which they provide services for consumers.
  • Debt settlement companies have relationships with creditors, enabling them to negotiate lower payoff arrangements than you would likely achieve doing it yourself.

What is Debt Settlement?

Debt Settlement is a debt relief option for those with overwhelming amounts of unsecured debt. Professional Debt Negotiators contact your creditors, discuss your hardship, and then negotiate a repayment plan for less than the amount currently owed. The repayment plan may consist of a single, lump-sum payment, or a term settlement over a period of months to satisfy the negotiated repayment plan.

When you pay only the minimum payment due on credit card bills you end up paying thousands of dollars more in interest before paying off the full balance and it could take 30 years or more to fully satisfy the amounts owed, even if you never charged another purchase. But for those experiencing a financial hardship like the loss of a job, reduction in hours, divorce, disability or the loss of a spouse, Debt Settlement can help you break the cycle of high-interest credit card debt and help you pay off your balances much sooner.

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Why Creditors Settle Debts for Less than the Full Amount Owed

Credit card companies, doctors, hospitals, and banks always want you to pay 100% of your debt plus interest and any fees accrued.

However, when you fall behind on payments, or default on the debt altogether, there is an additional cost to the company for collection services. Not only does the lender have to pay more to manage the account, but the value of the account falls, the more delinquent the account becomes. Missing multiple payments means you are less likely to bring the account current, and more likely the company will have to pay more to try and collect any outstanding balances.

Without collateral, lenders cannot take your property to repay the debt, giving the company limited ways to compel payment. Lenders can call, send threatening letters, or hire an attorney to initiate legal action. All these measures cost the company additional time and money. The company must pay an attorney to take you to court, get a judgment, and execute that judgment through liens or wage garnishments in hopes of collecting some or all the judgment. Some states make it challenging, if not impossible, to recover debts by garnishing wages, further incentivizing the company to work out a deal with you to collect some portion of the amount owed.

When all means of collection fail, the company can sell the debt to a debt buyer, who will pay pennies on the dollar for the uncollectable debt. Given the limited means to collect on a delinquent account, most debt buyers willingly accept a lower payoff if proposed by a debt settlement company.

How Does Debt Settlement Work?

The debt settlement process relies on three key elements:

  1. A demonstrated financial hardship used to illustrate an inability to repay a debt in full,
  2. an account that is not current to motivate the lender to negotiate the debt, and
  3. enough money saved to pay a lump sum or a series of payments to satisfy the agreed payoff.

The Debt Settlement Process

The first step to debt settlement is a free counseling session with a debt relief counselor. The counselor will assess your financial situation and discuss your hardship, debt, income, and expenses to decide if a debt settlement program is the right debt relief option for your needs.

Once it is determined that you qualify based on your hardship, you enroll in a debt settlement program, choosing which debts you want to include. Most debt settlement companies accept credit card debts, medical bills, personal loans, and other types of unsecured debt. After enrollment, you begin making payments into a dedicated FDIC-insured savings account every month. This “special purpose” savings account is owned and controlled by you. Neither your creditors nor your debt settlement company can touch the funds deposited here without your express authorization. The accumulated funds will then be used to negotiate and pay your creditors under the terms of negotiated settlements.

It typically takes several months to save enough money for your debt negotiators to effectively negotiate with your creditors, so the more money you save and deposit during the early months of the program will give your negotiators a better chance of settling one or more accounts sooner. During this time, your credit accounts become delinquent. As your accounts go further into delinquency, and/or eventually charge off, creditors become more motivated to accept at least a portion of what is owed.

Debt Settlement companies specialize in negotiating with creditors and maintain relationships with these creditors. Creditors understand that accounts enrolled with debt settlement companies are not likely to easily cure or resolve for full payment. Creditors also understand that consumers enrolled in Debt Settlement programs are motivated to save funds and settle accounts, so the parties work together to their mutual benefit, and the benefit of consumers to find a reasonable repayment plan the consumer can complete given their hardship. Once an agreement has been made, you will either make a single, lump-sum payment to satisfy the account, or, you may also opt to make a series of monthly payments until the repayment plan has been satisfied.

Either way, once you satisfy the terms of the repayment plan, you have no further obligation to pay the debt. The creditor can no longer make efforts to collect payments and cannot sell the debt to a debt buyer and the debt will be reported to the credit bureaus as “Settled in Full”.

If you do not miss any savings account contributions, you can typically eliminate all enrolled debts in two to four years. Adding additional funds each month to your savings account, such as money from a tax refund or bonus check, could speed up the process even more.

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How Does the Program Savings Account Work?

The Special Purpose Program Savings Account works as an escrow-like account. It is held at a bank and FDIC insured. You are the owner of the account and you retain control over the funds deposited to the account. The funds in the account will be used to make payments to your creditors when settlements are reached and to pay the fees to your Debt Settlement company.

Your debt settlement company will work with you prior to enrollment to establish a monthly deposit schedule that both fits your budget, and is designed to have you reach your goal of settling all accounts, usually in two to four years depending on how many accounts and how much debt is enrolled.

How Much Can You Save Using Debt Settlement?

Creditors typically accept between 30 and 80% of the outstanding balance, including accumulated late fees and penalty interest charges.

Missing a payment leads to late charges on the account, which adds to the outstanding balance. Interest also continues to accumulate until the account goes 180 days with no payment when it typically charges off. However, once the account charges off all interest charges and late fees cease and the balance no longer continues to grow.

It is important to know that regardless of how much the balance grows during the delinquency period, and before the account charges off, debt settlement companies always negotiate the settlement of an account based on the balance of the account on the day you enrolled in the program. This ensures the settlement reached by your creditor and debt settlement company does not reflect the additional fees associated with accumulated interest, penalties, or fees. This also ensures that any fees paid by you to the debt settlement company are calculated based on the balance of the debt on the day you enrolled in the program

How Long Will It Take to Settle Your Debt?

The length of time it takes to settle your debts can vary greatly and is determined by factors such as the amount of debt you enroll, the number of accounts you enroll, the type of debt enrolled and how much money you are able to commit to your savings plan.

Individual results will vary, but typically, most people who enroll in a Debt Settlement program enroll 4-7 credit card accounts with a total balance of $25,000 to $40,000 and usually complete their savings and repayment plans in 24-48 months. Depending on the amount of debt you enroll, and your ability to sufficiently save funds used to repay your creditors, your program timeframe may vary.

The Pros and Cons of Debt Settlement

The Pros of Using Debt Settlement

Pay the least amount out of pocket. Credit counseling, or debt management plans, require you to repay the full amount owed plus some interest. Under a Chapter 13 Bankruptcy, you are required to contribute 100% of your disposable income for five years before receiving any debt relief. However, settling with your creditors through a Debt Settlement program may help you resolve your debts cheaper than Credit Counseling, and faster than either Chapter 13 Bankruptcy or a Debt Management Plan.

Become debt-free in the shortest time. Credit counseling and Chapter 13 bankruptcy usually require payments for five years to complete the program, depending on the amount of your debt. However, if you do not miss any contributions to your Debt Settlement Program Savings Account, you could eliminate all enrolled debts in as little as two to four years in a Debt Settlement Program, and be in a position to begin rebuilding your credit file years sooner.

Only Chapter 7 Bankruptcy helps you shed debt with no obligation to repay qualifying debts, but comes with some serious drawbacks, including requiring the possible sale of some assets such as your home, automobiles, and other non-exempt assets, and the negative impact of filing bankruptcy can remain on your credit report for 7-10 years depending on which form of bankruptcy you end up qualifying for.

Can avoid bankruptcy. You can pay off high levels of unsecured debts without filing bankruptcy through debt settlement. The bankruptcy process requires you to sell (or pay the equivalent of) all non-exempt assets. You must also undergo court oversight during the five-year repayment process. Debt settlement avoids the implications of bankruptcy, costs less, and takes less time to pay off debts than Chapter 13 Bankruptcy.

Achieve immediate and long-term debt relief. Most participants can immediately cut monthly debt servicing payments by 50% or more, giving you immediate financial relief from high monthly payments you can no longer afford. The process also eliminates debts without requiring you to repay the full balance, saving you thousands of dollars in long-term debt relief.

The Cons Using Debt Settlement to Eliminate Debt

Creditors are not required to accept a lower payoff. When you owe money, creditors have the right to collect the full amount owed. However, the collection process is expensive, and many companies decide to accept a settlement to avoid further collection costs on the delinquent account.

Lenders also understand that you may not pay anything toward the outstanding balance if you file for bankruptcy.

Even though creditors are not required to negotiate debt balances, most companies have policies for consumers with demonstrated hardships that may allow you to pay a reduced amount on delinquent accounts to resolve the debt. Not all creditors or collection agencies work with debt settlement companies. However, your debt settlement company likely has a working relationship with the major credit card companies, debt buyers, and collection agencies and know which ones are less likely to settle. As such, you can choose which accounts to enroll in the program. If you are concerned one of your creditors may not work with a debt settlement company you are considering, just check their website for recent settlement or ask your financial consultant for a list of companies they typically work with to resolve accounts.

Negative impact on your credit. All debt relief options can result in a decline in your credit score. If you have not missed any payments, your credit score will initially suffer more than someone who has made periodic payments and already has delinquencies on their credit file. Having a good credit history can help your credit score recover faster than those who have missed payments over the last several years.

Any negative information on your credit file that negatively impacts your credit score becomes less impactful as time goes by and eventually will drop off your credit report after 7 years or 84 months.

Forgiven amounts could be taxable. When a creditor forgives $600 or more, the company may report the amount forgiven to the IRS. Not all creditors report debt forgiveness to the IRS. However, if you receive a 1099-C for forgiven debt, you must report it on your next tax return. Unless you can prove you were insolvent at the time of the debt forgiveness, you will pay taxes as ordinary income on the forgiven amount. While this happens infrequently, many who are enrolled in Debt Settlement programs can demonstrate their insolvency and reduce or eliminate their obligation to pay these taxes.

How Will Debt Settlement Affect Your Credit?

Payment history and credit utilization are the primary metrics credit scoring companies use to calculate your credit score. While your enrollment in a Debt Settlement program is not a reportable item to the credit bureaus, missing payments on your open accounts, or having those accounts fall into default will impact your credit score. However, if you already carry very high balances relative to your available credit lines, this high utilization of credit ratio is likely already negatively impacting your credit score. If you have missed any payments in the past 7 years, your score has likely been further negatively impacted.

Creditors and their collectors generally will not negotiate a deep settlement of a debt unless you have late payments, high utilization ratios, lower credit scores, or a combination of all three. When you fall behind on payments, the creditor may close your account. Doing so will further impact your credit utilization by reducing any available credit on the account to zero.

The FICO credit scoring models place the highest emphasis on the last 12 months of your payment history, giving you a chance to raise your score quickly once you begin settling your debt. Furthermore, in the FICO Score 9 models and higher, accounts previously in collection that are paid or settled in full are no longer considered as part of your credit score calculations, so settling debts as quickly as possible allows you to begin rebuilding your credit score much sooner than similar debt relief programs like Credit Counseling or Bankruptcy.

Should You Try Settling Debts Yourself?

You can always reach out to creditors and try to negotiate a settlement of your debts yourself. However, without a keen understanding of the credit lifecycle, the debt collection process, and what parameters each creditor uses, you are likely to pay more than the debt settlement company can achieve working on your behalf. Lacking an in-depth understanding of the process and company practices could also increase your chances of facing litigation before you save enough money to negotiate with creditors or unknowingly extending the statute of limitations period for collecting a  debt through litigation.

Debt Collectors are trained professionals with a single goal in mind: to collect as much money as possible from you. They also have a personal financial incentive to collect as much money as possible as they are paid partly on a commission basis. Debt Collectors are also trained to key in on the emotional nature of the transaction to gain an advantage in the negotiation process. If you can remove all emotion from the transaction, and you are an excellent negotiator, you may be able to reach a favorable settlement. For most people, being in debt is a stressful and emotional experience, and as such, they have a difficult time separating those emotions when speaking to aggressive debt collectors.

However, when a professional debt negotiator and a collection agent or creditor negotiate to settle a debt on your behalf, emotions are no longer a part of the transaction, and each party has a mutual interest to find a way to reach a negotiated settlement. This mutual interest serves both parties and is why Debt Settlement companies collectively resolve hundreds of millions of dollars in delinquent or charged-off debt each year.

What Happens if You Cannot Make Sufficient Savings Deposits to Complete the Program?

The main factor contributing to success in completing a debt settlement program is your ability to sufficiently and regularly make savings deposits so that your debt negotiators will have sufficient funds with which to negotiate the settlement of your debts. If you miss savings deposits, or are late in making those deposits, your savings balances could be insufficient to cover term settlements already agreed to and under contract for payment, or your savings balances may be insufficient for your debt negotiators to effectively bargain on your behalf.

For this reason, it is important to be open and honest with your debt counselor prior to enrollment; sharing honestly all information about your income and expenses so that your counselor can create a savings program for you that has the greatest chance of helping you complete the program and settle your debts in the shortest time possible.

An inability to complete a Debt Settlement program because you were not able to sufficiently save enough funds could result in higher debt balances due to late fees and penalty interest. You might need to repay balances in full or file bankruptcy to protect your income and assets from creditors.

Who Are the Best Candidates for Debt Settlement?

There are many debt relief options available today. It is important to be clear about your short-term and long-term financial goals and be willing to accept some negative financial impacts while you work to improve your situation. Understand that any program you choose requires focus, commitment, short-term financial sacrifices, and may negatively impact your access to credit or your credit score in the near-term.

When choosing an option to reduce your debt, it is important to be honest about your situation and select a program that is most suitable for your current situation and your financial goals. Below is a brief description of a few of the most popular options.

Chapter 7 Bankruptcy is the best choice if you do not have enough income to repay any creditors, and your income is below the median income in your state. Chapter 7 requires you to liquidate your assets to repay creditors, which means you could have to sell your home, automobiles, and other assets. A Chapter 7 Bankruptcy also stays on your credit report for 7 years, meaning you will likely not be able to obtain new credit during this time. Learn more about Chapter 7 Bankruptcy here.

Chapter 13 Bankruptcy is the best option if you are behind on your payments and want to save your house or vehicle from foreclosure or repossession or need relief from existing wage garnishments. Depending on how much you earn and what types of assets you hold, you will be required to pay back a portion of what is owed, have a receiver oversee your finances until your debt repayment is complete and pay attorney fees and attend court-required financial education courses. A Chapter 13 Bankruptcy impacts your credit score for the longest period because it is reported for 10 years. Learn more about Chapter 13 Bankruptcy here.

Credit Counseling, also referred to as a Debt Management Plan, offers relief for consumers who earn enough to repay all creditors within five years. You may need help simplifying the payment process, and you can save money through waived fees and lower interest rates, but you must demonstrate sufficient income to qualify, and if you can’t complete the program, creditors can roll back waived fees, accrued interest, and penalties, putting you deeper in debt. Learn more about Credit Counseling here.

Debt Settlement is best for consumers who face a financial hardship that makes it difficult or impossible to continue making the minimum payments on high-interest consumer debts. If you are current on your mortgage but want to get rid of credit card debt, personal loans, or delinquent medical bills, debt settlement may provide the greatest payment relief, and help you reduce or eliminate your unsecured debt in the shortest time possible. Debt Settlement, when compared to Bankruptcy, also lets you begin to recover your credit score years sooner, allowing you to move on with your life and rebuild your finances.

  • Is using debt settlement bad?

    Successfully resolving debt for less than the full balance requires you to stop making payments to creditors. This necessary step will impact your credit and will raise your debt balances initially. However, completing a debt settlement program could significantly reduce the amount paid when compared to Credit Counseling or just making minimum payments on your accounts.

  • How much will debt settlement impact my credit score?

    Late payments stay on your credit report for seven years. The impact on your credit score will diminish over time, with the largest impact occurring in the first 12 months. Once your accounts are settled, those accounts will impact your credit score less as time goes by.

  • How long will it take to rebuild my credit after debt settlement?

    When you settle debts, the seven-year clock starts at the first missed payment if you never bring the account current again. The largest impact on your credit score is during the first 12 months. After that, it will improve each month if you keep all open accounts current. The stronger your credit was before the default, the easier and faster your credit will rebound.

  • What is considered a good settlement offer on a credit card debt?

    While not all creditors will negotiate delinquent debts, creditors will typically accept settlement agreements of 30 to 80% of the outstanding balance. Your financial situation and the creditor’s policies play a significant factor in the type of agreement and the amount of savings you may secure.

  • Can I get settled debts off my credit report?

    In most cases, negative activity stays on your credit file for seven years. In some cases, creditors will agree to remove the information as part of the debt settlement agreement. You can also request that the company remove the information after the fact, but companies are not required to stop reporting accurate information to your credit file unless a prior agreement was made in writing.