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Debt settlement pros and cons

Negotiating with creditors can bring financial relief, but beware the risks

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Whether it's credit card debt, student loans or medical bills, debt can weigh heavily on your mind. One option you may be considering is debt settlement.

Whether debt settlement, also commonly called debt relief, is best for you depends on your unique financial circumstances. It’s important to understand the pros and cons and that there is no one-size-fits-all approach to eliminating debt.

Key insights

  • With debt settlement, you or a third-party company negotiate a reduced debt balance.
  • While settling debt reduces what you owe, it can also negatively impact your creditworthiness, depending on the tactics used.
  • Alternatives to debt settlement include a debt management plan (DMP), debt consolidation, debt forgiveness and bankruptcy.

What is debt settlement?

“Debt settlement is the process of negotiating with creditors to reduce the outstanding balance on debt, making it more manageable for the borrower,” explained Stanley Tate, a lawyer specializing in student loan debt.

You — or a third-party debt settlement company — negotiate an agreement that allows you to pay back your creditors less than you owe. Typically, creditors are willing to work with individuals who are behind on their bills. This demonstrates financial hardship; creditors might be less willing to negotiate down your debt if you are already making on-time payments.

The majority of the debt settlement companies we reviewed require enrolled clients to stop making all payments to their creditors so a lump-sum settlement can be reached. This method can help reduce your debt load, but it will also hurt your credit score, since on-time payments make up a large percentage of your score.

» MORE: How to negotiate credit card debt

How debt settlement works

There are two ways to pursue debt settlement: on your own or via a debt settlement company.

If you choose to settle on your own, you’ll need to prove you are experiencing financial hardship. An account over 90 days past due is usually one sign you are struggling to pay your bills. You will then need to contact your creditors directly when you are ready to settle; most creditors will want to settle for a lump-sum amount.

With a debt settlement company, the process looks similar, but the company works on your behalf to negotiate with the creditors. You will be required to stop paying your creditors and instead make a monthly payment to a separate account that the debt relief company can use for lump-sum payoffs. Ideally, your debt relief company will also negotiate the removal of late fees by creditors.

Some debt settlement companies charge high fees, which can negate the cost of savings on your debt. One ConsumerAffairs reviewer based in Utah said: “Many delays and hidden fees. Net savings over original debt is minimal and credit rating is destroyed long term.”

» MORE: Do I need a debt settlement lawyer?

Debt settlement costs

While going with a debt settlement company may seem costly, the question is whether the potential for a lower debt and having an expert negotiate on your behalf offsets the potential cost.

“In a DIY approach, borrowers handle the negotiation process themselves, which can be time-consuming and challenging without prior experience,” said Tate.

Debt settlement fees range from 15% to 25% of your enrolled debt, and your specific fee percentage is determined by the state you live in. We have seen companies charge as high as 30% for services.

Thankfully, these companies cannot charge you any fees until the debt is settled. While this is a relief for those who cannot pay the fee upfront, it can eat into your debt repayment savings.

For example, if you hire a debt relief company to help you with your $20,000 debt load, it might look like this:

  • Original debt: $20,000
  • Settled debt agreement: $10,000
  • 25% fee: $5,000
  • Total debt savings: Went from 50% to 25% after fees

It is also important to note that many companies require a minimum debt amount of $7,500 to $15,000 to enroll in services.

Pros and cons of debt settlement

Debt settlement is not a cure-all debt solution that should be rushed into. We recommend using debt settlement as a last resort before heading toward bankruptcy.

While debt settlement can reduce your debt burden and help you regain control of your finances, there are serious credit score and tax implications. Additionally, there is the possibility your creditor will sue you for payment or sell your debt to an aggressive third-party debt collector.

Weigh the pros and cons carefully before deciding if debt settlement is the right move.


  • Avoid bankruptcy: Given the long-term ramifications of bankruptcy, avoiding it is the preferred option for most people.
  • Peace of mind: The stress of carrying a large debt can be overwhelming. Negotiating (or having an accredited company do so for you) can provide peace of mind.
  • Reduced debt burden: “Successfully negotiating a settlement can significantly lower the amount owed,” said Tate.
  • Flexible requirements: Settlement does not require a credit check or for you to be in good standing with your creditors.


  • Tax implications: Unless you are deemed insolvent by the IRS, the debt relief you receive may be taxed as regular income.
  • Fees: Debt settlement companies charge fees to negotiate with creditors. Your unpaid debts can also rack up fees that might not be dismissed upon settlement.
  • Impact on credit score: Settled debt may imply to lenders that you are a risk, making it difficult to get financing in the future.
  • Can be sued: Creditors can sue you for your unpaid debts, which can lead to wage garnishments.

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    Alternatives to debt settlement

    There are a number of alternatives to settling your debt. The best option for you will be based on your unique financial situation.

    • A debt management plan is a program where you work with a credit counseling agency to create a payment plan to pay off your debts. The agency will work with your creditors to negotiate lower interest rates and fees.
    • Debt consolidation involves moving all your existing debts into one loan or credit card. This can simplify your payments and potentially lower your interest rate.
    • Debt forgiveness is when a creditor cancels a borrower’s owed balance, usually when the borrower has suffered an insurmountable financial hardship. It’s fairly uncommon but can be a lifeline if you’re eligible.
    • If your debts are simply too unmanageable, you may consider filing bankruptcy. However, this should be an absolute last resort and only if your creditors are unwilling to negotiate.


    Does debt settlement affect your credit?

    Yes, in the early stages of the debt settlement process, it is likely that your credit will be negatively impacted. However, depending on the amount of debt settled and the circumstances surrounding the settlement itself, your score can recover reasonably quickly.

    What percentage of debt can be negotiated?

    The exact percentage will vary based on the company you choose, your creditors and your current financial situation. Several of the debt settlement companies we profiled were able to reduce client debt load by an average of 50% to 55%. The total could be more; one ConsumerAffairs reviewer said, “I had $45,000 in debt and [the debt settlement company] have gotten every one of my debts, cut in half some over 60-70% off.”

    Is debt settlement better than bankruptcy?

    It depends. While bankruptcy is a risky option, it puts a stop to lawsuits and collection calls — which debt settlement does not do. The bankruptcy process is also shorter than the debt settlement process, though the negative impact can last longer. Personal bankruptcies stay on your credit report for up to 10 years.

    What’s the difference between debt settlement and debt management?

    During the debt settlement process, you negotiate a lump sum lower than your full balance to pay back to your creditors. With a DMP, you end up paying the creditors back in full.

    Bottom line

    If you’re considering debt settlement, it’s important you first take stock of your financial situation to determine if it is the best approach for you. Weigh the pros and cons and consider the alternatives before making any decision.

    ConsumerAffairs writers primarily rely on government data, industry experts and original research from other reputable publications to inform their work. Specific sources for this article include:
    1. Federal Trade Commission, “How To Get Out of Debt.” Accessed March 23, 2023.
    2. Consumer Finance Protection Bureau, “What are debt settlement/debt relief services and should I use them?” Accessed April 20, 2023.
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