How to Choose a Debt Settlement Company: Here’s What You Need to Know

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Debt settlement can reduce the amount you owe and make it easier to get out of debt. Your credit score will suffer, but it’s a solid alternative to bankruptcy if you have more unsecured debt than you can pay.

What Debt Settlement Services Do For Their Customers

Debt settlement companies work with unsecured debts, like credit card debt, personal loans, payday loans, and some private student loans. They won’t be able to help you with secured debt, like a car loan or mortgage, or with federal student loans.

Debt settlement companies negotiate directly with your creditors to convince them to accept less than what you owe. When a debt is settled, it’s gone: you no longer have to pay. It’s a way to eliminate debts without paying the full amount.

How Debt Settlement Works

  • You stop paying. Instead of paying your creditors, you pay into a dedicated savings account for debt settlement. The account is under your control.
  • The company negotiates the enrolled debts. When there’s enough in the account to make a credible settlement offer, the company’s negotiators go to work.
  • You pay the reduced amount. After a debt settlement plan is negotiated, you pay the creditor a lump-sum payment. The debt is gone.
  • You pay the debt settlement company. Reputable companies will not charge you until after they have settled debts.

There are potential downsides. When you stop making payments, you’ll rack up late fees and may be targeted by collectors. Accounts may be sent to collection agencies, you could start getting annoying collection calls and a debt collector or creditor could even sue you.

The debt settlement process can be a long one. Your credit score will also take a beating, but most people who use debt settlement have badly damaged credit already, so there’s not much to lose.

Remember that if the total amount of debt forgiven is more than $600, you must report it to the IRS as taxable income.

READ MORE: Is debt settlement the cheapest way to get out of debt?

How Much do Debt Settlement Companies Charge?

Most debt settlement companies charge a percentage of the total amount your debt is reduced. This is usually 15% to 25%, depending on state laws.

If your total debt is $20,000 and the company negotiates that down to $10,000, the total reduction of your debt would be $10,000. If the company’s fee is 20%, you’d owe the company $2,000.

The American Fair Credit Council estimates that the average debt settlement customer saves $2.64 for every dollar spent in fees.

READ MORE: How does debt settlement affect your credit score?

Factors to Consider When Picking the Best Debt Relief Company for Your Needs

If you’re looking for a debt settlement company, be careful. There are reputable companies out there, but there are also sketchy companies and outright scams.  

Here are some things to look for.

  • Minimum amounts of debt: Some companies will only accept clients with unsecured debts over a minimum limit.
  • Hardship requirements: Some companies only work with clients that have demonstrable hardships (like job loss, medical bills, or divorce), which makes negotiation easier.
  • Ability to pay: Companies may not want to negotiate on behalf of clients who have the ability to pay their debts.
  • Fees: The company should provide you with a clear list of all fees. No fees should be due until debts are actually settled.
  • Initial consultation: The company should provide a free consultation to assess whether debt settlement is right for you. Watch out for companies that use the consultation as a sales pitch!
  • Timetable: The company should give you a clear timetable for settling your debts. This will vary with the size of your debts and the amount that you can contribute to your debt settlement account.
  • Settlement account status: The account you pay into should be exclusively under your control. Do not make monthly payments into an account someone else can withdraw from!
  • Termination: Ask whether you can cancel the program without penalty, whether the settlement company can drop you, and under what conditions.
  • Experience: How many debtors, lenders, and credit card companies has the company worked with before?

Watch out for evasive or unclear answers. Company representatives should be able to answer these questions easily.

READ MORE: Debt settlement qualifications

Make Sure the Debt Settlement Company is Licensed

A debt settlement company should be licensed by your state’s financial regulator. Ask the company for their license number and if you have any doubts, check with the agency. Most state regulators have searchable websites.

Make Sure Any Debt Relief Company is Reputable

Check the reputation of any debt settlement company that you’re considering.

Almost any company will have some bad reviews or complaints, but a pattern of answered complaints or legal issues is a red flag.

READ MORE: Is it better to settle a debt or fully repay it?

Watch Out for Scams

Scams are common in the debt settlement industry, but they are usually easy to spot. Here are some danger signs:

  • The company calls you. Reputable companies won’t cold-call you. 
  • They over-promise. If a company promises to wipe out your debts or settle them for pennies on the dollar, watch out. That’s not realistic.
  • They charge upfront fees. Debt settlement companies should not charge fees until they have successfully settled debts.
  • Claims to be a government program. The government will not help you settle debts.
  • Avoids questions. Legitimate companies will answer questions clearly and without evasion.

The usual rule applies: if it sounds too good to be true, it’s not true!

If you’re contacted by a company and you believe it’s a scam, please report it to the Federal Trade Commission (FTC), or the Consumer Financial Protection Bureau (CFPB).

READ MORE: Debt settlement fees

Things Any Debt Settlement Company Should Tell You Before You Sign Up

The FTC says that you should expect a debt settlement company to offer the following information.

  • Fees and terms of service.
  • How long it will take to get results.
  • The possible consequences of stopping debt payments.
  • The impact of debt settlement on your credit score.
  • How much you’ll need to have in your third-party account before they start settling your debts.
  • The tax implications of debt settlement.

The company should supply this information without being asked. If they don’t, you may not be dealing with a reputable firm.

READ MORE: How much does a debt settlement lawyer cost?

Who are the Best Debt Settlement Companies?

There are many reputable debt settlement companies, but these six stand out.

All of these companies are well established, with extensive track records and good reviews.

READ MORE: Best debt settlement companies

Other Debt Relief Options to Consider

If you have serious debt problems but don’t think debt settlement is right for you, consider these options.

  • Debt consolidation combines multiple debt payments into a single account, simplifying your payments and potentially getting you a lower interest rate. You can do this with a debt consolidation loan or a balance transfer card, but you’ll need good credit. The key to making debt consolidation work is having the discipline to avoid taking on new debt until you’ve paid off your consolidated debts!
  • Nonprofit credit counseling agencies offer free sessions to help you evaluate your options and choose a debt relief plan that fits your needs. Credit counselors may recommend a debt management plan, which is a way to consolidate debts and negotiate better terms even with bad credit. Debt management plans can take years to complete and require discipline, but they can be a very effective way to get out of debt.
  • Bankruptcy: If there is no realistic way for you to pay your debts, bankruptcy is a way to wipe the slate clean and get a fresh start. The process is complicated and should only be considered as a last resort. You’ll need to decide whether you’ll need to use Chapter 7 or Chapter 13.

If you’re considering bankruptcy, talk to a bankruptcy attorney – most offer free initial consultations – or use the Upsolve app, which can walk you through a simple bankruptcy without a lawyer.

To learn more about Chapter 7 bankruptcy, check out this video:

The Bottom Line

Debt settlement isn’t for everyone. If your credit is still good and you have the capacity to pay off your debts, you’re probably better off with debt consolidation or a debt management plan. 

If your credit is already severely damaged and you have more debt than you can realistically pay, working with a reputable debt settlement company is a solid option to become debt-free. You can substantially reduce the amount you owe and clear your debts faster than you would by other methods! 

FAQs

Which Types of Debt Can be Settled?

Debt settlement is generally only possible with unsecured debts, like credit card debt, personal loans, payday loans, and some private student loans. Secured debts (like a mortgage or car loan) and federal student loans can’t be settled.

Does the Government Have a Debt Relief Program?

The government has forbearance, deferral, and installment programs for debts owed to the government, like federal student loans or tax debt. The government has no debt relief programs for private loans.
If someone calls you and claims to represent a government debt relief program, you’re being scammed.

Is a Debt Settlement Program Better Than a Debt Consolidation Loan?

If you have reasonably good credit and you can pay your debts, consolidation is usually a better option. If your credit is already shot, you cannot pay your debts and you’re considering bankruptcy, debt settlement is a better option. Compare the two in-depth here.

How Will Debt Settlement Affect My Credit Report?

Debt settlement will cause serious damage to your credit. Debt settlement companies will ask you to stop making payments. Late payments will be reported, and accounts may be charged off and sent to collections.
Settled debts will be reported as settled for less than the amount owed, further damaging your credit.

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