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Everything You Need To Know About Debt Settlement

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In a Nutshell

Debt settlement is a type of debt relief. If a creditor agrees to a debt settlement, you make a lump-sum payment for less than the total debt you owe and they forgive the rest. This can work well if you have a large sum of cash at hand. But many who've fallen behind on paying their debts don’t. If you try to save up money to settle a debt, you'll hurt your credit in the meantime if you stop making your debt payments.

Written by Mae KoppesLegally reviewed by Attorney Paige Hooper
Updated August 7, 2025


Debt settlement is a type of debt relief that may allow you to settle certain debts for less than what you owe. You can negotiate directly with your creditors or hire a debt settlement company to do the work for you. Whether you hire a company or do it yourself, you’ll need a lump sum of money to make an offer. If you hire a company, you’ll likely pay into an account until you’ve saved enough money to make a good settlement offer.

Like any debt relief solution, debt settlement isn’t for everyone. In this article, you’ll learn more about how debt settlement works and what the benefits and risks are.

What Is Debt Settlement?

Debt settlement is a way to deal with debt by negotiating with your creditors to pay less than the full amount you owe. 

💸 In most cases, you offer a lump-sum payment, and if the creditor agrees, they forgive the rest of the balance. For example, if you owe $6,000, you might settle the account by paying $3,000 and having the remaining $3,000 wiped away.

You can try settling debts on your own by contacting your creditors directly, or you can work with a debt settlement company that negotiates for you. Each option comes with its own pros and cons, depending on your situation and how comfortable you are handling the process. We’ll cover all this more in depth in this article.

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

Debt settlement only works with certain types of debt. 

✅ Generally, this includes unsecured debts like credit card debt and medical bills.

❌ You usually can’t settle secured debt like the loan you took out to buy your house or your car. 

You can only settle student loan debt in rare cases. To do so, you usually have to negotiate a settlement with your student loan company directly.

How Long Does Debt Settlement Take?

The time frame to settle your debts will depend on your resources. If you have a chunk of cash to devote to settlement, you can start the negotiation process 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 need to save up.

If you’re working with a settlement company, you’ll make monthly payments into a special account the company sets up. 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 resolve the debt. 

Why Are Creditors Willing To Settle Debts?

Creditors often agree to settle because getting something is better than getting nothing. If you’re behind on payments and struggling financially, they may see a lump-sum offer as their best chance to recover part of the debt. 

From their point of view, accepting a lower payment now may be smarter than risking that you’ll file bankruptcy later and they’ll get nothing at all.

Debt settlement can also save creditors time and effort. Instead of spending months or years chasing down payments or working through collections, they can close out the account and move on.

Keep in mind, though, not all creditors are willing to settle debts.

Pros and Cons of Debt Settlement

Debt settlement can be a helpful tool for dealing with certain kinds of debt, but it’s not without risks. Understanding both the benefits and the downsides can help you figure out if this is the right path forward.

What Are the Potential Benefits of Debt Settlement?

When it works, debt settlement can have many upsides, including:

  • Settling your debts faster than other options like a debt management plan

  • Reducing the total amount you pay on your debts

  • Helping you avoid filing for bankruptcy

Debt settlement can give you relief from debts faster than many other options. For people dealing with credit card debt, medical bills, or other unsecured debts, this can be a way to put the stress behind them more quickly. If the creditor accepts your settlement offer, you’ll pay a lump sum that’s less than the full balance. Once you’ve made that payment, the account is closed and the remaining debt is forgiven.

Some people also turn to debt settlement to avoid filing for bankruptcy. While both options can damage your credit, debt settlement usually doesn’t stay on your credit report as long as a bankruptcy does. For folks who want to move on from their debt but keep bankruptcy as a last resort, debt settlement might feel like a more manageable compromise.

Another possible benefit is the cost and time savings. If you’re able to negotiate a solid settlement and you have money saved up to pay it, you could resolve the debt much faster than through a debt management plan or long-term repayment schedule.

What Are the Downsides of Debt Settlement?

Debt settlement has several risks that are important to think through, including:

  • Not all creditors will agree to settle your debts

  • It can seriously damage your credit score for several years

  • It sometimes leads to extra fees, interest, and collections while you’re negotiating

For starters, not all creditors are willing to settle. Some may refuse to negotiate, or they might require a higher settlement amount than you can afford.

Also, debt settlement usually only works after you’ve already fallen behind on payments. That means you may rack up late fees and interest while waiting to settle, and your credit score will likely take a hit from the missed payments. 

Accounts that are settled are closed, which affects your credit history and your available credit, both of which are major parts of your credit score.

Even after you’ve settled, the debt might be reported as “settled for less than the full amount” on your credit report. This can stay on your credit history for up to seven years, although the impact will fade over time as you rebuild your credit.

Finally, there could be tax consequences

Tax Consequences of Debt Settlement

When you settle a debt for less than the full amount, the part that’s forgiven is usually considered taxable income. If the amount forgiven is $600 or more, the creditor may send you a Form 1099-C, and you’ll need to report that amount on your tax return. 

📈 This can increase your total taxable income for the year, which might lead to a bigger tax bill than you expected.

There are some exceptions, though.

How Does Debt Settlement Affect Your Credit Score?

Debt settlement can hurt your credit in the short term. Since you’re paying less than the full balance, creditors usually report the account as “settled for less than owed,” which lowers your credit score. 

If you’ve already missed payments, your score may have dropped before the settlement process even began. And once an account is settled, it’s typically closed, which can impact your credit history and available credit. 

🗓️ This negative information can stay on your credit report for up to seven years.

Still, settling a debt means it’s resolved. You’ll have a $0 balance on that account, which gives you a clean slate to start rebuilding your credit. Over time, as you make on-time payments and use credit responsibly, your score can improve. 

DIY Debt Settlement vs. Hiring a Debt Settlement Company

You can negotiate debt settlements on your own for free. If you don’t have the time, energy, or confidence to do it yourself, you can hire a debt settlement company to handle the negotiation for you and oversee your debt settlement fund. 

DIY Debt Settlement

With DIY debt settlement, reach out directly to your creditors to try to negotiate a lower payoff amount. 

To get started, you can contact your creditor by phone or mail. If you’re not sure what to say, you can use a debt settlement letter to make your offer in writing. This can be a helpful way to explain your situation, propose a settlement amount, and keep a clear record of your request.

Upsolve has a free debt settlement letter you can use, or you can work with our partner SoloSuit to settle your debt for a small fee.

Hiring a Debt Settlement Company

If you choose to hire a company, it’s crucial to do your research. Some debt settlement companies are reputable and have proven settlement track records. But others have serious issues.

Before signing up with a debt settlement company, research the company carefully. You can look at the company history or search for complaints through the Better Business Bureau, the Consumer Financial Protection Bureau (CFPB), the FTC, and your state’s attorney general.

Pros and Cons of Hiring a Debt Settlement Company

There are some advantages to hiring a company to settle your debts for you. For one, it may be less stressful since the company handles the debt negotiation. 

Also, some debt settlement companies have knowledge of and relationships with major creditors, so they know how to make offers that creditors are likely to accept.

But there are also many downsides. The first is that you’ll have to pay a fee for their services. If the company you hire is really good, you may still save money overall, but this is hard to know when you hire. 

Another downside is that you’ll need to do careful research before you hire a company to avoid the many debt settlement scams out there. The CFPB warns against working with companies that make specific promises about how much they can reduce your debt. It’s also a red flag if a debt settlement company asks you for upfront payment.

What Other Debt Relief Options Are There?

When you’re struggling financially, it’s best to learn about multiple options and take the time to choose the best one for you. Bankruptcy, debt consolidation, and debt management plans (DMP) are three common alternatives.

Debt Consolidation

A debt consolidation loan combines multiple debts into one larger loan. You still pay the total amount of your debt, but your monthly payments will be more manageable. 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.

Debt consolidation loans can be hard to get if you’ve already fallen behind on your payments and your credit score is low. It may be easier to get approved for a secured loan, like a home equity loan, to cover the debt you’re having trouble paying. But this can be risky because creditors can take your property if you can’t keep up with the payments.

Debt Management Plans (DMPs)

A debt management plan works a lot like a debt consolidation loan. But instead of taking out a loan, a nonprofit credit counseling agency creates and administers a repayment plan. They also work 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.

Upsolve partners with Cambridge Credit Counseling, an NFCC-accredited nonprofit that provides free consultations for people interested in learning more about DMPS.

Cambridge is an affiliate partner, which means Upsolve may earn a small commission if you choose to use their paid service. This helps keep our services free.

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. 

Chapter 7 usually works best for people who have mostly unsecured debt and don’t own a lot of property.

Let’s Summarize…

Debt settlement is one of many potential debt relief solutions. If a creditor agrees to a debt settlement, you’ll make a lump-sum payment for less than the total debt you owe and they’ll forgive the rest. Debt settlement can work well if you have a large sum of cash at hand. But many people don’t. In that case, you may hurt your credit by stopping your debt payments and taking time to save up a settlement fund.

If you aren’t sure where to start on your journey to a debt-free life, you can schedule a free consultation with a nonprofit credit counseling agency that can help you better understand your options.



Written By:

Mae Koppes

Mae Koppes (she/her) is a Certified Personal Finance Counselor® (CPFC) and the Content Director at Upsolve, where she focuses on producing accessible and actionable content that helps empower people to overcome financial hardships. Since joining the team in 2021, she has played a... read more about Mae Koppes

Attorney Paige Hooper

LinkedIn

Paige Hooper is a seasoned consumer bankruptcy attorney with 15 years of experience successfully representing debtors in Chapter 7, Chapter 11 and Chapter 13 cases. Paige began practicing bankruptcy law in 2006 and started her own solo, multi-state bankruptcy practice in 2012. Gi... read more about Attorney Paige Hooper

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