Debt Settlement: Is it the Fastest Way to Get Out of Debt?

Considering a debt resolution program? It's a quick and effective way to get out of debt. Reduce multiple payments into one and lower your monthly payments up to 50%.

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The average American has a little over $90,000 in consumer debt, though some U.S. households owe much more than that. If you need debt relief, debt settlement is often one of the fastest — and least expensive — solutions. But most people don’t understand how it works.

Key points

  • Debt resolution companies negotiate with your creditors to “settle” your debts for less than the full amount you owe.
  • In exchange for this service, you pay anywhere from 15% to 27% of the total debt you enroll in the program.
  • There are no upfront fees — you don’t pay until your debts have been settled, and if your creditor refuses to settle, you don’t have to pay the debt resolution company at all for that particular debt.
  • The average debt settlement customer ends up debt-free while paying about 20% less than the full total they owe, even after paying those fees.
  • Most debt settlement companies require at least $10,000 in unsecured debt (or $1,000 in payday loan debt) to be eligible to enroll.

Featured Solution: DebtHammer

Our Top Pick for Help With Debt
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Disclaimer: Credit Summit may be affiliated with some of the companies mentioned in this article. Credit Summit may make money from advertisements or when you contact a company through our platform.

What is Debt Settlement?

Debt settlement — which is also sometimes called a debt resolution program — is simply the process of renegotiating, settling, or in some way altering the terms of a borrower’s debt to a creditor or debt collector. Many people aren’t aware that credit card companies and other lenders are often willing to negotiate and lower the total amount of debt you owe them. Compared to alternatives such as debt consolidation loans, credit counseling, Debt Management Plans (DMPs) and bankruptcy, it’s the fastest way to eliminate unsecured debt.

Pro tip: It also may be called debt reduction, debt relief, debt negotiation or a debt consolidation program. However, it is not the same as debt consolidation, which involves using a new loan to pay off your other debts, leaving you with one monthly loan payment.

There are two ways to settle debts – hire a debt resolution company or try to do it yourself.

READ MORE: Is it better to settle a debt or pay in full?

What is a Debt Resolution Program?

A third-party debt resolution program will contact your creditors and settle your debts for an amount that’s less than the total you owe. But first, they will meet with you and review your financial situation. They will set you up with a designated savings account and instead of making your monthly payments on your own, you will send money to the debt resolution company, which will deposit it until settlements have been reached. At that point, the money from your savings account will be used to pay the settlements. 

The debt resolution company does the heavy lifting, and in exchange, you pay them a fee ranging from 15% to 27% of the total debt settled. However, you’ll likely need to have at least $10,000 in unsecured debt (or $1,000 in payday loan debt) to be eligible to enroll in a program.

This process is also sometimes called debt settlement.

How Do Debt Resolution Programs Work?

  1. The borrower intentionally withholds payment to creditors
  2. The borrower makes monthly deposits into a dedicated savings account
  3. The debt relief company negotiates new terms with creditors on behalf of the borrower
  4. A settlement offer is reached, and the borrower must approve the settlement
  5. The borrower makes the settlement payments from their dedicated savings account
  6. The process is repeated until all debts are settled and all loan payments have been made

Pro tip: If you don’t want to hire a third-party company to negotiate settlements, you contact the creditors and negotiate settlements on your own. This can be a good option if you’re a skilled negotiator and have the time to devote to the process. However, the process can be very time consuming if you need to settle multiple debts. Plan to devote about the same amount of time you’d spend at a part-time job.

Who Qualifies for Debt Settlement?

Not everyone will be a good candidate for debt resolution, but it will be a viable option for the following people:

  • Those with more than $10,000 in unsecured debt (credit card bills, medical bills, personal loans)
  • Those with more than $1,000 in payday loan debt
  • People who can only afford to make the minimum monthly payments
  • People facing a financial hardship
  • People who are afraid to add up their total debt
  • Those who already have charged-off debt or are getting multiple calls from debt collectors
  • Those who are willing to take a temporary hit on your credit score (or have a credit history that’s already less than ideal)

READ MORE: Debt settlement qualifications

Who Does Debt Settlement Help?

Almost all unsecured debts are eligible for debt settlement. That means it works for more than just credit card debt relief. Personal loans, medical bills and some private student loans. However, certain unsecured debts, including child support, alimony and back taxes, cannot be settled.

Pro tip: Secured debts, like car loans and mortgages, are not eligible for debt settlement. This means if your debts are primarily secured debts, debt settlement isn’t a good choice for you.

How Much Does a Debt Resolution Program Cost?

Most companies charge between 15% and 27% of the enrolled debt (any debt you enroll in the program). Say, for example, you enroll $30,000 in the program. The company will charge based on that amount, not the amount you owe after settlement. In many cases, debt settlement can be cheaper than other debt relief options. 

So if you enroll $30,000 in a debt settlement program, and the company reaches settlements that total $15,000 but charges a fee of 25% the total enrolled debt ($7,500), you’ll end up debt-free while paying about $22,500, saving a total of $7,500.

READ MORE: Debt settlement fees

How Long Will Debt Settlement Take?

The length of time it will take to complete a debt settlement program will depend on the total amount of debt you enroll. If you’re in a payday loan debt resolution program, you’ll likely be finished within 12-18 months. If you’re enrolling larger amounts of debt, it could take as long as four years. The length of a program will depend on several factors, including: 

  • The total amount of debt you enroll in a program
  • The amount of money accrued in your designated spending account
  • The settlement totals reached
  • How long you’ve already been making payments on the debts
  • The amount of money you’ve already paid to the creditor

How to Choose a Debt Resolution Program

A third-party debt settlement company will be the middleman between you and your creditors. 

First, a legitimate debt settlement company will review your information to determine whether debt settlement is your best option. You will need to feel comfortable discussing your finances with the company you choose. The process won’t work as it should if you aren’t completely honest. A few other debt-relief options may better suit your needs, including debt consolidation and bankruptcy. A legitimate company will also know which creditors are open to settlements. 

READ MORE: How to choose a debt settlement company

Pro tip: If a debt settlement company tells you they can’t help you, it’s nothing personal. Debt settlement isn’t the best option for every borrower who needs relief. A reputable company will review the debts you have and will be honest about whether or not debt settlement is a viable option. 

The company should be forthright and professional. You need to trust that the company offers you the best possible option. If you feel uncomfortable or don’t think they’re making the best recommendations for your case, get a second opinion from another reputable company.

Pro tip: When Credit Summit ranked the top debt settlement services, our top pick was DebtHammer, due to the array of options and helpful customer service team. Set up a free consultation now to discuss your options.

READ MORE: Best debt relief companies

When Does Debt Settlement Make Sense?

The debt settlement process is time-consuming and complicated. The four years it can take to successfully complete a program sounds like a long time, and because creditors and lenders are not obligated to settle debts, it does not always work.

However, debt settlement could save you a lot of money if all goes well. 

According to the American Association for Debt Resolution, debt settlement provides an average of $2.64 in consumer savings for each $1 fee assessed.

In addition, more than 98% of settlements result in a debt decrease that is greater than the fees charged.

Is Debt Settlement Worth It?

Debt resolution programs are often a better option than Chapter 7 bankruptcy, which will destroy your credit score. The cost of debt settlement depends on a few factors, such as the types of debt and the amount owed.

Most debt settlement companies charge between 15% and 27% of the enrolled debt (any debt you enroll into the program). 

Here is a comparison of how much you’d spend — and how long you’d be making payments — if you have $25,000 in debt:

Debt settlementConsumer credit counselingMinimum monthly payments
Total cost$19,780$32,087$57,793
Total debt repaid$13,800$25,000$25,000
Months to pay off or settle all debts48 months48 months400+ months

READ MORE: Debt settlement vs. Debt Management Plans (DMPs)

A few companies charge a flat fee for their services, but this isn’t that common. Some will charge based on the end result or the amount saved instead of the amount enrolled.

Whatever their payment system is, these companies cannot charge anything until after the process is complete, according to the Federal Trade Commission (FTC).

If you want to try your hand at debt settlement but don’t want to pay, it’s possible to do it yourself by calling your creditors to negotiate.

READ MORE: How to pay off $20,000 in credit card debt

How Does the Debt Resolution Process Work?

After your initial consultation, the debt settlement company will ask you if you will stop making monthly payments on your unsecured debts. (You’ll keep paying secured loans like mortgages and car loans and any routine bills you have.)

Why stop payments? The reason is simple. Most creditors won’t consider settling debts until the account is charged off.

Three things MUST happen before a debt settlement company is allowed to collect its fees. Under FTC law, a fee can ONLY be collected:

  1. When at least one of the client’s debt obligations has been renegotiated, settled, reduced, or issued new terms AND
  2. When a written settlement agreement, debt management plan, or other agreement has been made between the customer and the creditor that the client agrees and accepts AND
  3. When the client has made at least one payment to the creditor following the agreement that the service provider negotiated.

Pro tip: Charged off means that the creditor has given up hope that your debt will be paid, and has notified the three credit bureaus of this. Charge offs are noted on your credit report, will significantly hurt your credit score and do not release you from the obligation to repay the debt. 

READ MORE: How debt settlement works

You’ll Deposit Money Into a Special Savings Account

As you wait for your debts to be charged off, you’ll set up a savings account and deposit all the money you would have been paying your creditors during that timeframe. This will give you some savings to use as leverage in the negotiations.

After each account is charged off, the debt settlement company will start negotiations. Each creditor will be offered a fixed-term payment. 

There Are No Upfront Fees

You don’t have to pay a debt settlement company until your debts have been settled. If your creditor refuses to settle, you don’t pay for that particular debt at all. During the settlement process, you’ll make regular deposits into a savings account earmarked to pay any settlement agreements. When you’ve approved a settlement, it will be paid through that savings account, either as a lump sum or a payment plan. The fee will also be deducted from your account at that time.

READ MORE: Debt settlement fees

Pro tip: The money in your designated savings account is YOUR MONEY. If your debts aren’t settled, you will get the money back. 

What Happens If I’m Unhappy With the Settlement Offer?

You must agree to the terms of any settlement agreement. You are not obligated to accept the terms if you aren’t satisfied with the offer. Nothing will move forward without your approval.

After a deal has been reached, you likely will start making payments to the debt settlement company, which will make the payments on your behalf. This will continue until the settled debt has been repaid in full, which customarily ranges anywhere from 12 to 48 months, depending on the total debt settled.

Pro tip: Some settlements (DIY in particular) will involve making a single lump-sum payment instead of repaying the debt over time. This is why setting up a savings account is so important.

How to Avoid Paying Taxes on Settled Debts

Be aware that the Internal Revenue Service (IRS) could count any settled debts as taxable income, which means you could face a tax bill when tax time rolls around. For example, if you have $2,000 in payday loan debt and you reach a settlement for $1,000, the IRS views the $1,000 in canceled debt as “income.” You will likely receive an IRS Form 1099-C from your creditor. If your debt falls into an excluded category, you won’t need to include it as regular income on your tax filings.  

Taxpayers are considered insolvent when their total liabilities exceed total assets. In many debt settlement cases, it’s possible to claim insolvency to have the forgiven debt excluded as income.

For example, if you have $20,000 in total liabilities and your total assets are $16,000, you are insolvent in the amount of $4,000.

The IRS says, taxpayers are not required to include forgiven debt as income if the taxpayer can show insolvency. However, to do that, you must complete and file Form 982: Reduction of Tax Attributes Due to Discharge of Indebtedness (and Section 1082 Basis Adjustment.) 

Pros and Cons

Relatively quick reliefCreditors could refuse to settle
No upfront feesInterest, late fees will accrue when you stop making payments
Repay your debt fasterSecured debts aren’t eligible
Most unsecured debts can be settled,
including payday loan debt
You’ll need to have thick skin to deal with debt collectors
Stops debt collector callsIt could take up to four years to complete the process
You can avoid bankruptcyYou may have to pay taxes on the forgiven debt

READ MORE: Pros and cons of debt settlement

How to Find a Legitimate Debt Resolution Company

Unfortunately, the industry has its share of scammers, but there are a few ways to recognize legitimate companies:

  • There are no upfront fees
  • The company does not guarantee to settle debts or lower interest rates
  • The timeframe the company gives you is realistic (the industry average is 12 to 48 months). Beware of any company that promises immediate results. It will take at least a few months.
  • The company has favorable reviews on sites like the Better Business Bureau.
  • The company does not have many unresolved consumer complaints online.

READ MORE: How to choose a debt settlement company

Pro tip: If you’re in doubt about a particular company, contact the Consumer Financial Protection Bureau (CFPB) or another local consumer protection agency. Ask them if there are any negative reports about the company. In some states, legitimate debt settlement companies must be licensed, so check on that.

The CFPB also offers some safeguards.

How Does Debt Settlement Affect Your Credit Score?

Debt settlement will initially cause your credit score to drop, but the damage won’t be as significant as you fear, and it will eventually rebound. If you’re overwhelmed by debt, you likely have already established a pattern of late payments and high debt utilization ratios, so your credit score is probably already less-than-ideal. And remember, it will be easier to get started on credit repair once your debts are paid off.

READ MORE: Debt settlement’s impact on your credit score

How Long Does Debt Settlement Stay on Your Credit Report?

A settled debt will remain on your credit report for seven years from the original date the debt became delinquent.

However, the status of your debt will change from “charged off” to “settled” as soon as you have made any settlement payments. This will help your credit score because it indicates you’ve taken responsibility for your debt. It will help show potential lenders, landlords and employers that you take your financial obligations 

Some creditors are willing to negotiate how your settlement will be reported to the credit bureaus. Any accounts marked “paid in full” will look normal to employers.

How Long Will It Take to Improve Your Credit Score?

The faster you pay off your settlements, the quicker your score will rebound. As soon as your settlements are noted on your credit reports, your credit score will start to improve. Your credit score will continue to rise in the long run because your credit utilization ratio will be lower. But ultimately, your credit score will depend on what you do after the settlement. Your credit score prioritizes the most recent entries, so responsible use and on-time payments will help your score bounce back.

READ MORE: How to build credit

Debt Settlement vs. Debt Consolidation: Which is Better?

The best option for you will depend on your circumstances. If you need to maintain a good to excellent credit score and will qualify for a debt consolidation loan with a low interest rate, consolidation is the ideal option. However, if you have a credit score that’s “fair” or below, are struggling to make your payments each month or have more than $20,000 in unsecured debt and can’t see a way out, debt resolution could be a good exit strategy.

READ MORE: Debt settlement vs. debt consolidation

More Debt Relief Options

READ MORE: Debt relief options

The Bottom Line

If you’re struggling with a large amount debt, debt settlement can provide the relief you need. Just make sure the company you choose is reliable, easy to work with, accessible and can answer your questions upfront. Choosing the right company gives you the best shot at long-term success.


How Long After Debt Settlement Can I Buy a House?

There isn’t a fixed timeline for how long it will take to qualify for mortgage approval after debt settlement. Your qualifications will depend on your overall credit score and whether you meet the lender’s requirements. Borrowers with larger down payments may be able to qualify for mortgages despite lower credit scores. But the key factors will be employment, down payments, credit history and debt-to-income ratios. 

How Do I Cancel a Debt Settlement Contract?

binding document, so there are some steps you must follow. 
Review your contract – it should specify any fees you’ll have to pay
Contact the company and ask about the cancellation process – some may require notice in writing
If you’ve given the company permission to automatically debit your bank account, contact your bank and rescind that access
Pay the penalty fees
Once you’ve paid any fines or penalties, you’ll receive a refund for the deposits you’ve made to your escrow account
Contact your creditors to ask about repayment options

READ MORE: How to get out of a debt settlement contract

What is a 1099-C Form?

RS Form 1099-C is used exclusively for cancellations of debts for which a debtor actually incurred the underlying debt but did not have to repay it. Any time a debt of $600 or higher is forgiven, whether through debt resolution or other means, your creditor is required to send you this form by January 31 of the following year. You will need these forms to complete your taxes. 

How Do I Negotiate a Settlement with a Debt Settlement Attorney?

The process of working with a debt settlement attorney is similar to working with a debt resolution company. Many debt settlement law firms work on contingency, meaning that the amount you pay them will be based on the final settlements. However, it’s also possible to hire a law firm on an hourly basis, or some law firms may require a “retainer,” or a fee for future services.
If you need an attorney specifically for debt resolution, look for an attorney that charges no upfront fees who can show a track record of success for clients.

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

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