Takeaways
- Debt settlement allows you to pay an amount lower than your unpaid balance.
- Debt settlement companies charge a percentage fee of the reduced balance.
- Before hiring a debt settlement company, try a Do-it-yourself (DIY) approach.
- Strategies that debt settlement companies use can damage your credit score.
- Debt relief options include debt settlement, debt management plans, and bankruptcy.
When debt becomes unmanageable and monthly payments are no longer affordable, it might be time to explore debt relief options, like debt settlement. Household consumer debt has continued to rise. In fact, in the first quarter of 2025, U.S. credit card debt reached $1.18 trillion.[1]
For those struggling to make payments, debt settlement can provide significant relief in the right circumstances by allowing you to negotiate with creditors to pay less than the full amount you owe. However, it is essential to understand that debt settlement also carries risks and consequences that you should be aware of before moving forward.
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How Debt Settlement Works
Debt settlement is the process of working with your creditors, or through a third-party company, to settle unsecured debt for less than you owe. In most cases, creditors agree to a reduced lump-sum payment in exchange for considering the account "paid in full." According to The American Association for Debt Resolution (ACDR), its members can reduce consumer debt balances by about 32% after fees.[2]
Debt settlement is typically used for unsecured debts like:
- Credit cards
- Personal loans
- Medical bills
- Collection accounts
It is not typically available for secured debts like mortgages or car loans, and federal student loans are also excluded.
>> Too Much Debt? Read about the 30% Rule
Here’s When Debt Settlement Is Right for You
Debt settlement is not a one-size-fits-all solution, but it can be helpful in specific situations. You may consider it if:
- You have significant unsecured debt (usually $10,000 or more)
- You are behind on payments and cannot catch up
- You are not eligible for a debt consolidation loan
- Bankruptcy is a last resort, and you want to avoid it
- You are willing to accept damage to your credit score in exchange for a lower total repayment.
Debt settlement is often considered a last-chance option before filing for bankruptcy. It may be appropriate if you are facing severe financial struggles, but you can still set aside cash for lump-sum settlements.
Read More: 5 Reasons You Have a Low Credit Score
How to Get a Debt Settlement Plan
Creating a debt settlement plan is key to getting rid of your debt. Here are the typical steps to take when getting a debt settlement process in place:
- Stop Making Payments—Many settlement companies will advise you to stop paying your creditors so they can use non-payment as leverage in negotiations. Non-payments often result in late fees, damaged credit, and collection calls. (Read more about How to Get Your Free Credit Report).
- Save Money in a Dedicated Account—Instead of paying creditors, you deposit funds into a special savings account, which you use to pay settlements once agreements are reached. (Read about How to Open a Savings Account).
- Negotiate Settlement Amounts—The company or individual representing you contacts creditors to negotiate a lump-sum payment, often targeting 40% to 60% of the unpaid balance.
- Settle and Pay—Once a creditor agrees to the offer, the agreed-upon sum is paid from your dedicated savings account.
- Repeat for Other Debts—The process continues until all your included debts are negotiated and settled. You want to do this until you pay off all your debts.
3 Steps to Choose a Debt Settlement Company
You can pursue debt settlement independently or work with a professional debt settlement company. If you choose to hire a company, here’s what you need to do:
1. Research Companies Carefully
Not all debt settlement companies are reputable. Look for companies accredited by the American Association for Debt Resolution (AADR) or the International Association of Professional Debt Arbitrators (IAPDA). Avoid companies that guarantee results or charge high upfront fees. These could be scams.
2. Understand the Fee Structure
It is crucial to understand debt settlement companies' fee structures. They typically charge a percentage of the total debt enrolled or the amount saved through settlement.
Fees often range between 15% and 25% but are only charged after a successful settlement. Understanding how these fees work will empower you to make more informed decisions about which company to use or if you should pursue a Do-It-Yourself approach.
3. Review the Contract
Before enrolling, understand how long the program will last (usually 24 to 48 months), what happens if a creditor refuses to settle, and what consequences you may face if you stop making payments.
Alternatives to Debt Settlement
Debt settlement is not the only path toward financial relief. Depending on your situation, one of the following options may be more appropriate:
1. Debt Management Plan
Nonprofit credit counseling agencies offer debt management plans that consolidate payments and reduce interest rates without requiring you to default on your debt. This method helps protect your credit score and avoids late payment fees.
2. Debt Consolidation Loan
If you qualify, a debt consolidation loan allows you to combine multiple debts into one lower-interest loan. This simplifies repayment and may reduce the total interest you pay over time.
One of the main benefits of debt consolidation is that it streamlines your payments because you only have to make one payment. With debt consolidation, you don't have to juggle payment timing and multiple credit cards or loans.
3. Bankruptcy
If you face extreme financial hardship, Chapter 7 or Chapter 13 bankruptcy may offer a legal and comprehensive path to discharge or restructure your debt. However, bankruptcy has lasting impacts on your credit report, and you should seriously consider the long-term consequences of this option.
Smart Summary
Debt settlement is a financial strategy that allows you to negotiate with creditors to pay less than the full amount owed. It can provide significant debt relief for those facing large amounts of unsecured debt and repayment difficulties. However, it has serious consequences, including credit damage, tax liabilities, and service fees. But if you have thousands of dollars of unsecured debt you can't seem to pay off, debt settlement might be for you.
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(1) New York Federal Reserve. Household Debt and Credit Report. Last Accessed May 15, 2025.
(2) Association for Consumer Debt Relief. A Regulated, Proven Path to Financial Recovery. Last Accessed May 15, 2025.
