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Get Rid of Debt and Save Money with Debt Settlement

January 24, 2025

Debts can easily get out of control. With inflation, Americans are relying on credit cards for everyday expenses. Interest rates are higher than usual. Salaries haven’t kept up. It all adds up to overwhelming debt. 

Living in debt is stressful. You are handling calls from debt collectors and creditors, all of whom want money that you simply do not have. Debt settlement may seem like a lifeline if you cannot afford to repay what you owe. It is risky, but it can help you get out of debt for less.

Find out how settling works and if it’s the right solution for you.

What is debt settlement?

Debt settlement is a form of debt relief. It is when you or a debt settlement company negotiates with creditors to pay less than the full amount you owe. Creditors will typically agree to a lump-sum payment – not installments. Once the creditor accepts the settlement, the remaining balance is forgiven. 

Settling debts helps you reduce what you owe and become debt-free. Creditors may agree to forgive as much as 50% of your outstanding balance. The process is not without risks. It works best for people who are severely behind on payments, are struggling with high levels of debt, and have no other way to repay their lenders. 

What types of debt can be settled? 

Debt settlement only applies to unsecured debts. Unsecured debt includes credit card balances, medical bills, and personal loans. These are debts not backed by collateral. 

Secured debts generally cannot be settled as they are tied to assets that lenders can repossess. Examples include mortgages, auto loans, and federal student loans. It also will not apply to student loans or taxes owed. Always check with your creditor to confirm whether your specific debt qualifies for settlement.

How does debt settlement work?

Assess your financial situation

Take a hard look at your finances. Write down everything you owe, income, and essential expenses. Find out how much you can afford to pay each month. Debt settlement works best for consumers who are significantly behind on payments and cannot afford to keep up with minimum payments due.

Contact your creditors or a settlement company

You can negotiate directly with creditors or work with a professional debt settlement company. If you choose a settlement company, they will handle negotiations on your behalf, but be aware of service fees. On average, debt settlement companies charge 15% to 25% of the enrolled debt for their services. The fee may be worth it as they have negotiation experience.

Stop making payments

Stopping paying creditors is a controversial part of debt settlement. While not a requirement, creditors are more willing to negotiate when payments are overdue. You may be advised to stop making payments to build leverage and instead put money aside for a lump-sum payment. Not paying the minimum will further damage your credit score and incur additional late fees. Since you’re in a debt settlement program, you are likely already behind on payments, and your score has already suffered.

Offer a settlement amount

Once you’ve saved enough to negotiate, the debt settlement company will reach out with an offer. Creditors may agree to this reduced amount to avoid the risk of not being paid at all.

Finalize the agreement

Always get the agreement in writing. Put down that the creditor will forgive the remaining balance after the settlement payment is made. A written agreement protects you from future disputes.

Pay the agreed amount

Make the payment as agreed, either as a lump sum or through a structured plan. After this, the remaining debt will be forgiven.

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Risks of debt settlement

Settlement can be one of the cheapest ways to become debt-free, but it comes with risks. A big concern is the damage it does to your credit. Your score will drop significantly due to missed payments. Your account will be marked as “settled for less than the full amount.” The negative mark will stay on your credit report for up to seven years and will make lenders wary of working with you. 

The missed payments not only hurt your score but will cause your debt to grow. You will continue to accrue interest on your balance, and your lender will likely charge late fees. The debt settlement process can take years. Over time, your debts can grow. If you can’t settle all your accounts, you may not save money.

Debt settlement is not free. Companies charge a fee of 25% to 50% of your enrolled debt. The IRS considers forgiven debt over $600 taxable income. You may not have to pay taxes but speak with a professional first. 

Finally, there’s no guarantee that the settlement will work. Before you go this route, find out if your creditors negotiate with debt relief companies.

How to choose a legit debt settlement company

The debt relief industry has its fair share of scams. Do your due diligence and choose who you work with carefully. Legitimate companies will be accredited, have a successful track record, and have good customer reviews.

1. Read reviews and look for accreditations

Start by reading reviews on the Better Business Bureau, Consumer Affairs, and Reddit. These sites will give you an idea of how they handle complaints and what ordinary people say. Customers can tell you whether this is a company you want to work with.

The company you choose should be accredited by organizations like the American Fair Credit Council (AFCC), the American Association for Debt Resolution, or the International Association of Professional Debt Arbitrators (IAPDA). Accreditations by an outside organization indicate they adhere to industry standards and ethical practices.

2. Consider the fees

Debt settlement companies can only charge a settlement fee after successfully settling your debt. Their fee is considered a performance fee. It will be a percentage of the debt you enroll. Stay away from any company that asks for payment upfront. 

The performance fee is the big one, but companies will charge other fees. They may charge a monthly maintenance fee if you’re putting money in a savings account. You could incur a late payment fee if you make a late payment. Look over all the potential fees before you agree to settle your debt.

3. Take the introductory call

Enrolling in a debt settlement program is a significant move. Companies know that, and so many offer a free, no-obligation call. Take the phone call to get a sense of who the company is. Ask about their fee structure, exactly how much the service will cost, and how long it will take. Find out if you will work with a dedicated account manager. Discuss how settlement can impact your credit score. Talking to a representative can give you a feel for the company and if these are people you want to work with. The ideal company will be transparent about the whole process.

Debt settlement red flags to avoid

Now that you know what to look for in a debt settlement company, let’s review a few red flags. 

  • The company guarantees success or promises to eliminate all of your debt.
  • You are asked to pay an upfront fee before your debts are settled
  • The company advises you to stop communicating with your creditors.
  • The contact you’re given is vague and does not include details like timeline and costs.
  • The representative you speak with uses high-pressure sales techniques to rush a decision.
  • The company advertises itself as a government program.
  • The representative assures you they can stop debt collection lawsuits.

Other ways to tackle overwhelming debt

Debt settlement isn’t the only way to get out of debt. Consider all your debt relief options before you dive in. 

Debt consolidation loan

A debt consolidation loan is when you roll multiple debts into one – ideally with a lower interest rate. You take out a new loan and use the money to repay your current debts. You are left with a single monthly payment at a lower interest rate.

The idea behind debt consolidation is to simplify repayment and save money.

The single monthly payment is easier to manage. You are less likely to miss a due date and incur late fees. Personal loans almost always have a lower APR (annual percentage rates) than credit cards. A lower APR can save you hundreds, if not thousands of dollars, as you repay your debts.

Before you decide to consolidate your debt, make sure that you will save money and can afford the new loan. Loans come with fees. If you have a bad credit score, you may get a loan with a high interest rate and lots of fees. The cost of the loan may outweigh the benefits of consolidating debt. If you can’t afford the monthly payments, you need a different solution.

Balance transfer credit card

Balance transfer cards are another way to consolidate your credit card debt. You transfer outstanding credit card balances to a new card with an introductory low or 0% APR for the first 12 to 21 months. Pay off your debt during the promotional period, and you won’t pay a dime in interest. It is an effective way to knock out debt and save money on interest.

To qualify for a balance transfer card, you will need good to excellent credit. If you do get one, check that you can pay off your entire balance during the promotional period. Otherwise, you’ll be charged a higher APR and may not see any savings. Most cards also only apply to low APR to balances transferred. If you make purchases with the card, they will likely be subject to a higher APR.

Balance transfer cards also come with fees. The transfer fee is typically 3-5% of the amount transferred. The fee can easily eat into your savings. Make sure that you will save more than you’ll pay in fees.

Debt management plan

Debt management plans (DMP) are an excellent way to get out of debt. They are similar to debt consolidation, but your credit score doesn’t matter. Instead of getting a loan on your own, you work with a credit counselor. 

The credit counselor will negotiate with your current creditors for reduced interest rates and waived fees. The idea is to make your monthly payments affordable. You then pay the agency and they distribute the money to your creditors.

DMPs take three to five years to complete, and they charge fees. The fees are minimal and may be reduced or waived depending on your income.

As with all debt relief methods, it’s a good idea to stop using credit when paying off debt. If you enroll in a DMP, however, you may be required to close your accounts. Even so, DMPs are an excellent way to eliminate debt efficiently and save money. 

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Bankruptcy 

Bankruptcy is another option when you have no hope of paying off your debts. The advantage of bankruptcy is that it’s a legal procedure. You get to wipe out unsecured debts and stop dealing with debt collectors.

Individuals can file for either Chapter 7 or Chapter 13 bankruptcy. Other bankruptcies are reserved for businesses. Chapter 7 is considered liquidation bankruptcy. It erases unsecured debts in three to four months, but you must sell assets.

Chapter 13 bankruptcy lets you keep your assets. You’re put on a court-approved repayment plan that takes three to five years to complete. Complete the plan, and your remaining unsecured debts will be discharged. 

Bankruptcy is a way out of debt that offers legal protection but will severely damage your credit score. Chapter 13 will remain on your credit report for up to seven years, and Chapter 7 for up to ten years. It will be very hard to qualify for a loan or credit card after declaring bankruptcy. 

Talk to a bankruptcy attorney before you go this route. 

Is debt settlement right for you?

Debt settlement is a risky choice. It can get you out of debt for less, but there are no guarantees. Settlement works best if you’re already very behind on payments and have delinquent accounts. You already have the late fees, the additional interest, and the leverage to negotiate with creditors. 

Most debt settlement companies will not work with you unless you owe at least $10,000 in unsecured debts. Owing $20,000 or more is even better. The high number is because settlement is a good choice if you have no realistic hope of repaying your debts in five years. 

Debt settlement is an alternative to bankruptcy. If your chosen career doesn’t allow you to declare bankruptcy, settling debt can be your only option. Always explore debt consolidation and debt management plans first. 

While settlement can help if you can’t afford to make minimum payments, you do have to save up for a lump-sum payment. Make sure that this is doable before you engage a debt settlement company.

Frequently asked questions

1. How much will I save with debt settlement?

How much you save depends on the negotiations. Debt settlement companies promise to save you 20% to 50% of your total debt. It sounds like a lot, but then you must pay their fees and taxes to the IRS.

2. Will settling debt impact my credit score?

Settling debt will negatively affect your credit score. To negotiate a settlement, you will have to be behind on payments. Missing multiple payments can easily lower your score by 100 points. A settled debt is noted on your credit reports, making lenders less likely to approve you for loans or cards.

3. How can I build credit after debt settlement?

You can build credit by making timely payments every month and keeping your credit card balances low. Do not apply for a lot of credit cards or loans at once. If you need extra help, take out a credit-builder loan, become an authorized user, or report rent payments. The best thing you can do is consistently pay on time, and your score will increase.

4. Are debt settlement companies worth the costs?

Debt settlement companies can be worth the cost if you cannot negotiate with creditors on your own and need professional help. It is a way to get out of unmanageable debt without declaring bankruptcy. Keep in mind that the fees can be significant and there are tax implications. Weigh the potential savings against fees and risks before committing.

5. How long does the debt settlement process typically take?

The debt settlement process usually takes 24 to 48 months. The timeline depends on how quickly you can save enough funds for settlement offers and how willing creditors are to negotiate. While it may take years to complete, some settlements can occur faster if you provide a lump-sum payment early in the process.

Bottom line

Debt settlement can provide much-needed relief when you’re downing in debt. You pay what you can, and the rest of your debts are forgiven. It can appear cheap and easy at first glance, but settlement comes with its own risks and price tag.

Take the time to assess your finances and explore other options first. Settling debt may be worth it if you’re way behind on payments, your credit score is already low, and there’s no realistic way to pay everything you owe. Settlement is a way out without the negative implications of bankruptcy. You can get a fresh start.

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About the author

Rachel Alulis

Rachel Alulis has been the lead editor for Moneyfor’s credit cards team since 2015 and for the financial rewards team since 2023. Before joining Moneyfor, Rachel worked at USA Today and the Des Moines Register. She then established a successful freelance writing and editing business specializing in personal finance. Rachel holds a bachelor’s degree in journalism and an MBA.

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