What Is Debt Settlement? [2023] - All You Need To Know!

Wondering What is Debt Settlement? Keep reading!

Having too much debt sometimes feel like lifting a heavyweight which is holding you back in life.

Whether you are struggling with managing your debts, cannot pay your bills, or considering declaring bankruptcy, debt settlement is the cheapest way to get out of your debt and get your finances back on track.

And did you know according to Supermoney, Debt enrollment with debt settlement companies grew by over 2,500% from 2012 to 2020.

While this option might work well for some people, it is not risk-free.

In this guide, we’ll be talking about what debt settlement is, how it works, and the pros and cons so you can decide whether it can help you get out of debt. Let’s get started!

Key Takeaways

Debt Settlement involves offering a lump-sum payment to a creditor in exchange for forgiving a chunk of your debt.
Debt settlement is a savior for those who are facing a temporary financial setback and want to avoid bankruptcy.
You can do settlement yourself or by opting for a debt settlement agency.

Debt Settlement

Debt settlement is a form of debt relief or debt adjustment that allows consumers to resolve their debts for less than the current amount of their debt.

It involves offering a lump-sum payment to a creditor in exchange for a chunk of your debt being forgiven.

You can settle their debts personally or hire the best debt relief firm that acts as a middleman between you and your lender and negotiates to reduce or eliminate your debt.

Debt settlement is the best option for someone facing a temporary but significant financial setback and considering bankruptcy as an alternative. ¹

Read: Difference Between Debt Settlement And Debt Consolidation

How does Debt Settlement Work?

Debt settlement is typically done with the help of a non-profit credit counseling agency, but you can also do it on your own if you are confident enough that you’ll be able to convince your creditors².

Debt settlement companies will contact your creditors on your behalf and can negotiate a better payment plan or reduce your debt for a fee, often a percentage of the amount you’d save after settling your debt.

They may also advise you to stop paying your creditors until a debt settlement agreement is settled and make regular deposits into an account controlled by you but administered by an independent third party.

Debt settlement providers usually review all clients before they enroll to ensure they qualify for debt settlement and will be able to make necessary payments to pay back the debt.

Once the debt settlement company successfully negotiates with your creditor, you must agree to the terms of the agreement and make at least one payment to the creditor for the settled amount. ³

Read Our Debt Relief Review Methodology

Pros and Cons

Here are some pros and cons that you must consider before agreeing:

Pros

It helps you get relief from unbearable debt and repay your debt faster than other routes.
Also, it helps you avoid being sued for credit card debt and facing contentious court proceedings.
It is a great way to avoid bankruptcy that severely damages your credit score and stays on your credit report for a lifetime.

Cons

Debt settlement providers charge hefty fees between $300-$5000 or even more.
It negatively impacts your credit score that may affect your future loan term, employment opportunities, etc.
Debt settlement providers hold you cash which you could be using to do better things.
By stopping making late payments or interest fees, you could end up with bigger debt.
You’ll still be responsible for paying taxes on the reduced debt. ⁴

Debt Settlement Vs. Debt Management

In a debt settlement, the goal is not to reduce the actual amount of debt you owe but to help you pay your creditors each month with the least damage to your credit score and with a reduced interest rate.

So in debt management, a credit counseling agency ideally talks to your creditor and convinces them to reduce the interest payment.

They also help in consolidating your loans so that you have to make only a single payment towards your debt instead of multiple payments.

Debt management is better than debt settlement as it does not damage your credit score the way a settlement does.

However, in debt management, you will be required to close down all your cards, and you will have to pay fees to a debt management company if you do not choose a non-profit agency. ⁵

How to Negotiate Debt With Your Creditors?

Debt Settlement Alternatives

If debt settlement is not working for you, then here are some alternatives to debt settlement that you should have a look at:

Debt Consolidation

If you can repay your debts but are having trouble managing multiple monthly payments toward them, debt consolidation might be a better choice for you.

In this, all your debts are consolidated into a new single loan that too with a lower interest rate, so you only have to make one payment each month.

Debt consolidation is even good for your credit score as compared to debt settlement.

Balance Transfer

Another thing that you can do is get your debt or due balance on your current credit card or cards transferred to a new card with a zero APR offer.

So till the offer lasts, you will not be charged any interest rate making it easier for you to make payments towards your debt.

However, they will start charging you interest rate again once the promotional period (8-12 months ends).

So make sure you go for this option if you know you can repay your debt in this time period or can make the most out of it.

Bankruptcy

If you think you are drowning in debt and it is not possible to repay it back practically, then bankruptcy might be the last resort for you.

You can either file for chapter 7 bankruptcy or chapter 13 bankruptcy, depending on the type of debt you owe.

Also, you should know that bankruptcy remains on your credit report for 7-13 years. ⁶

How To Avoid Debt Settlement Scams?

If you are taking professional help instead of going for the DIY approach of debt settlement, then you should be wary of debt settlement scam companies.

Here’s how you can look for red flags in a debt settlement company:

Making prior false promises: Remember, a legit debt settlement company will never make any prior commitment or promises saying that they will get you out of debt. This is because your creditors are not obligated to listen to them and might not agree to a settlement at all. So there is no way one can promise that they will get this settlement done.
Advance fees: All legit debt settlement companies always ask you to pay them once they have settled your debt. Any company asking for advance payment is fake.
Not transparent: Debt settlement comes with many risks, and if your chosen company doesn’t inform you about the associated risks and disadvantages, then that’s a red flag. ⁷

Wrapping Up

Debt settlement is not the best option to go for, and it comes with a lot of repercussions.

If this is still something that you would like to do, then consider all possibilities and choose the option that’s best for you. We hope this guide on what debt settlement is is useful for you.

FAQ

What percentage of debt settlement can I get?

You can start by offering to pay 25% of the debt you owe, but the debt settlement company will also negotiate and counter with a greater amount.

The key here is to offer a percentage that is even less than the actual percentage you want.

Can debt settlement damage my credit?

Yes, debt settlement damages your credit score and can make it difficult for you to get any loans in the future because of your poor credit score.

Is debt settlement worth it?

Considering the damage it does to your credit and the fact that debt settlement history also remains on your credit report for seven years shows that it is no better than bankruptcy.

You should consider opting for a balance transfer or debt consolidation instead. ⁸

NPC Overall Rating

Amit Gupta

Amit Gupta is the founder of National Planning Cycles, a company that helps startups, individuals, and small businesses with their financial planning. He has a vast amount of experience in the finance sector, having managed Google Play accounts for some of the world’s most successful unicorns. Amit is an expert in his field, and he uses his knowledge to help others achieve their individual goals.

ARTICLE SOURCES

The National Planning Cycles is committed to producing high-quality content that follows industry standards. We do this by using primary sources, such as white papers and government data alongside original reporting from reputable publishers that were appropriate for the accuracy of information while still being unbiased. We have an editorial policy that includes verifiable facts with due credit given where applicable.