In a Nutshell

Debt settlement is a type of debt relief that may allow you to settle your debts for less than the full amount due. Most debt settlement programs work by setting aside money to negotiate with, then making settlement offers one debt at a time. But, like any debt relief solution, debt settlement isn’t for everyone. In this article, you’ll learn more about how debt settlement works, the benefits of making lump sum payments, and the risks you should know about.

Written by the Upsolve Team.  
Updated July 22, 2020


Debt settlement is a type of debt relief that may allow you to settle your debts for less than the full amount due. Most debt settlement programs work by setting aside money to negotiate with, then making settlement offers one debt at a time. But, like any debt relief solution, debt settlement isn’t for everyone. In this article, you’ll learn more about how debt settlement works, the benefits of making lump sum payments, and the risks you should know about.

How Debt Settlement Works

Debt settlement advertising often focuses on the idea that you can get out of debt by paying only a fraction of the amount you owe. The concept is simple: contact credit card companies and other creditors and offer each a lump sum payment. Many creditors will accept partial payment if you are prepared to pay the settlement amount all at once.

When you enter a debt settlement program, the debt settlement company handles the debt negotiation for you. Of course, that spares you uncomfortable calls with creditors. But, there may be other benefits as well. A debt settlement company may be able to use knowledge and relationships to make settlement offers creditors are more likely to accept. The company may also know which creditors are likely to settle, and about how much they’ll need to offer. They can use that information to decide which debts to tackle first.

How debt settlement works and how long it takes depends on your resources. If you have a chunk of cash to devote to settling debts, the negotiation process can start right away. But, most people considering debt settlement don’t have ready cash. If you don’t have cash available to start making settlement offers, you’ll enter into a settlement plan and start making monthly payments to the debt settlement company. When there’s enough money in your settlement fund, the debt settlement company will make an offer to one of your creditors. If the creditor accepts, you enter into a settlement agreement with that creditor, make the lump sum payment, and that debt is resolved. On to the next!

What Types of Debt Can Be Included in a Debt Settlement Plan?

Like every debt relief solution, debt settlement has limitations. Only certain types of debt can be handled through debt settlement. Generally, this includes unsecured debts like credit card debt. Secured debt, like the loan you took out to buy your house or your car, generally can’t be included. Student loan debt also usually can’t be handled through debt settlement companies or a debt management plan--especially federal student loans. But, you may be able to negotiate a settlement directly with your student loan company.

Research Debt Settlement Companies

If you’re considering debt settlement, it’s more important than ever that you do your homework. Some debt settlement companies are reputable and may be able to save you money. But, the success rate for debt settlement programs is low. And, the Federal Trade Commission (FTC) and other government agencies have caught some debt settlement companies breaking the law. Before signing up with a debt settlement company, research that company carefully. Some resources you can use to check out the company’s history include the Better Business Bureau, the Consumer Financial Protection Bureau (CFPB), the FTC, and the website of your state’s Attorney General.

You should also be on the lookout for red flags when talking with the debt settlement company. For instance, debt settlement companies aren’t allowed to ask you for upfront payment. If a company asks for a fee in advance, you probably don’t want to work with that company. The CFPB also warns against working with companies that make specific promises about how much they can reduce your debt.

Other Debt Settlement Risks

Even when you’re working with a reputable debt relief company, debt settlement has downsides. For most people, the debt settlement plan involves saving up settlement funds across months or years. Often, the debt settlement company will tell you to stop paying your creditors during that time. Partly, that’s so you can use the money you would have paid to the creditors to help settle debts. But, it’s also partly because creditors are more likely to settle if they’re not getting paid at all.

During this time, there is nothing to stop creditors from trying to collect the debt or turning it over to a collection agency. You will likely continue to get collection calls and threatening letters You may even be sued and have your wages garnished or your bank account frozen. And, your creditors will likely be reporting every missed payment to the three major credit bureaus. Your credit report will look worse and worse, and you may see a big drop in your FICO credit score.

Debt settlement can also get you into trouble with the IRS. Debt that’s written off as part of a settlement agreement may be considered taxable income. Debt settlement companies don’t always warn you about the tax consequences. So, you may be in for a big shock when you file your income taxes. 

Other Debt Relief Options

When you’re struggling financially, it’s best to learn about multiple options and take the time to choose the best one for you. Some common alternatives to debt settlement include bankruptcy, debt consolidation, and debt management (DMP). 

Debt Consolidation Loans

A debt consolidation loan combines multiple debts into one larger loan. The total amount of your debt is still paid in full, but in a more manageable way. Ideally, the new loan will have a lower interest rate, and the single monthly payment will be less than the combined amount you were paying before. But, debt consolidation loans can be hard to get if you’ve already fallen behind on your payments and your credit score is low. And, taking out a secured loan to cover debt you’re having trouble paying can be risky, since creditors can take your property if you can’t keep up payments.

Debt Management Plans (DMPs)

A debt management plan works a lot like a debt consolidation loan, except there is no loan. A nonprofit credit counseling agency administers the plan and works out payment terms with your creditors. The agency takes your monthly payment and distributes funds to the creditors as agreed. Because you aren’t taking out a loan, you don’t need good credit to get into a DMP, and you don’t have to provide property as collateral.

Bankruptcy

If you have a lot of unsecured debt you can’t pay, Chapter 7 bankruptcy may offer a solution. Many types of unsecured debt, like credit card debt, medical bills and payday loans can be eliminated in a Chapter 7 bankruptcy. But, you can’t discharge secured debt unless you’re willing to give up the property. Chapter 7 usually works best for people who have mostly unsecured debt and don’t own a lot of property.

Upsolve Helps People Find Debt Solutions

Upsolve is a nonprofit organization created to help people get out of debt and live debt free. We help people who want to file for Chapter 7 bankruptcy on their own, but we know everyone’s financial situation is different. The best option for you may depend on many factors, including the type of debt you have, the amount of debt you have, your current interest rates, your income, your credit score, the property you own, and your personal financial goals. So, we work hard to make sure you have access to the information you need to make good decisions for your future.

If you aren’t yet sure what type of debt relief you’re looking for, spend some time exploring our resources. You can learn more about bankruptcy, debt consolidation, credit counseling, and debt management plans on this site. We can also help you find a nonprofit credit counseling agency or connect you with a local bankruptcy lawyer.



About the author
The Upsolve Team

Upsolve is lucky to have an incredible team of finance and consumer rights professionals as contributing writers to help us keep our content up to date, informative, and helpful for everyone.

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Upsolve is a 501(c)(3) nonprofit that started in 2016. Our mission is to help low-income families who cannot afford lawyers file bankruptcy for free, using an online web app. Spun out of Harvard Law School, our team includes lawyers, engineers, and judges. We have world-class funders that include the U.S. government, former Google CEO Eric Schmidt, and leading foundations. It's one of the greatest civil rights injustices of our time that low-income families can’t access their basic rights when they can’t afford to pay for help. Combining direct services and advocacy, we’re fighting this injustice.

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