How it works in brief
- Debt settlement means negotiating with creditors to accept less than the full balance.
- Settlement companies usually have you stop paying creditors and save into a dedicated account instead, which damages your credit.
- By federal rule, companies cannot charge fees until they settle at least one debt and you make a payment under that settlement.
- Forgiven debt may count as taxable income.
In this article
What to expect
- Fees: often about 15% to 25% of enrolled debt
- No fees allowed before a debt is settled
- Your savings account must be yours, and you can withdraw anytime
- Creditors do not have to agree to settle
Federal rules from the FTC Telemarketing Sales Rule. Fee range reported by CBS News. Risks summarized from the CFPB.
Debt settlement is the debt relief option most people mean when they see ads promising to cut what you owe. It can work for people who truly cannot pay in full, but it has real costs.
Below is how a debt settlement program runs, what the law requires, and a worked example of the real cost.
What debt settlement really costs
| Example | Amount |
|---|---|
| Debt enrolled | $12,000 |
| Settled at 55% of the balance | $6,600 paid to creditors |
| Company fee at 22% of enrolled debt | $2,640 |
| Total you pay | $9,240 |
| Forgiven debt that may be taxable | $5,400 |
That is about $2,760 less than the enrolled balance, before late fees and interest that build while you save, and before the credit damage from missed payments. Settlement percentages vary widely, and creditors do not have to agree to settle at all.
How a debt settlement program works
- Month 1You enroll unsecured debts and start monthly deposits into a dedicated account you own.
- Months 1 to 6+Payments to creditors usually stop. Late fees and interest build, and your credit score drops.
- When enough saves upThe company negotiates a settlement on one account at a time.
- After each settlementYou approve it, the creditor is paid, and only then can the company take its fee.
- End of programPrograms often run several years until every enrolled debt is settled or dropped.
See if debt relief makes sense for you
SponsoredWhat the law requires of settlement companies
Under the FTC rule, a debt relief company must:
Compare debt settlement and other relief options
Debt relief rules and programs vary by state. Add your ZIP code to see options that serve your area. Looking is free and commits you to nothing.
The risks to weigh
- β Credit damage. Missed payments and settled accounts can stay on your credit report for up to seven years.
- β Lawsuits. A creditor can sue you while you are saving up.
- β Growing balances. Late fees and penalty interest can pile up before a settlement is reached.
- β Taxes. Forgiven debt may be taxable income. See is forgiven debt taxable?
- β No guarantee. Some creditors refuse to settle at all.
Luis enrolls $20,000 of card debt
Luis enrolls $20,000. His creditors settle for an average of 50%, or $10,000, and the company charges 20% of enrolled debt, $4,000.
He pays $14,000 in total instead of $20,000, but his credit score falls sharply, and $10,000 of forgiven debt may be taxable unless he qualifies for an exclusion such as insolvency.
Illustrative example. Names and numbers are made up to show how it works.
Frequently asked questions
How much does debt settlement cost?
Fees are often about 15% to 25% of the debt you enroll, on top of the settlement amounts you pay creditors.
How long does debt settlement take?
Programs often take several years, because you have to save enough to fund each settlement.
Will debt settlement stop lawsuits?
No. Creditors can still sue while you are in a program.
Is debt settlement better than bankruptcy?
Not always. Compare both in our <a href="bankruptcy-vs-debt-settlement.html">bankruptcy vs debt settlement guide</a>.
See debt help options for your situation
SponsoredSources
- FTC: Final rule to protect consumers in credit card debt (Telemarketing Sales Rule, 2010)
- CFPB: What is a debt relief program and how do I know if I should use one?
- CBS News: How much do debt settlement companies charge?
- IRS Publication 4681: Canceled debts, foreclosures, repossessions and abandonments
- CFPB: How long does negative information remain on my credit report?
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