Debt Settlement: How Does It Work And Is It Worth The Risks?

John Egan is a veteran personal finance writer whose work has been published by outlets such as Bankrate, Experian, Newsweek Vault and Investopedia.

John Egan is a veteran personal finance writer whose work has been published by outlets such as Bankrate, Experian, Newsweek Vault and Investopedia.

John Egan is a veteran personal finance writer whose work has been published by outlets such as Bankrate, Experian, Newsweek Vault and Investopedia.

John Egan is a veteran personal finance writer whose work has been published by outlets such as Bankrate, Experian, Newsweek Vault and Investopedia.

Managing Editor, Global Data and Automation for Forbes Advisor. Mitch has more than a decade of experience as personal finance editor, writer and content strategist. Before joining Forbes Advisor, Mitch worked for several sites, including Bankrate, I.

Managing Editor, Global Data and Automation for Forbes Advisor. Mitch has more than a decade of experience as personal finance editor, writer and content strategist. Before joining Forbes Advisor, Mitch worked for several sites, including Bankrate, I.

Managing Editor, Global Data and Automation for Forbes Advisor. Mitch has more than a decade of experience as personal finance editor, writer and content strategist. Before joining Forbes Advisor, Mitch worked for several sites, including Bankrate, I.

Managing Editor, Global Data and Automation for Forbes Advisor. Mitch has more than a decade of experience as personal finance editor, writer and content strategist. Before joining Forbes Advisor, Mitch worked for several sites, including Bankrate, I.

Updated: Jun 10, 2021, 12:30pm

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When you’re struggling with overdue debt, you may wonder whether debt settlement is the right way to take care of it. It may be a workable option, depending on which approach you take: relying on a third-party debt settlement company or settling the debt on your own.

Experts warn that using a debt settlement company can be a costly, risky alternative. Meanwhile, a DIY settlement plan may work, but it can be tough to carry out.

Read on to learn about the ins and outs of working with a debt settlement company.

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Fee for Settlement

The Basics of Debt Settlement

Debt settlement, also known as debt negotiation, involves wiping out debt by paying a portion of it in one lump sum. This sum typically is much less than what you originally owed.

For the borrower, debt settlement can provide financial relief and put them on the path toward rebuilding their credit. For the creditor, debt settlement enables them to receive at least some of the money they’re owed rather than no money at all. Furthermore, it may mean the borrower can avoid filing for bankruptcy. Although, according to some experts, filing for bankruptcy may be the better alternative in some cases.

Normally, debt settlement involves money you owe to credit card issuers, rather than other types of debt. But you may be able to settle other unsecured debt as well.

How Debt Settlement Works

Debt settlement handled by a debt settlement company differs from taking a DIY approach. Here’s what the process looks like when hiring a debt settlement company.

1. Research debt settlement companies. A number of legitimate debt settlement companies operate in the U.S. Most states require that they be licensed. Debt settlement companies are supposed to follow industry regulations that are designed to protect consumers and their money.

2. Be cautious. If a debt settlement company promises certain results, proceed carefully. For example, they can’t guarantee that a creditor will even agree to a debt settlement. In the course of your research, check the websites of your Better Business Bureau, your state attorney general’s office and consumer protection agencies like the federal Consumer Financial Protection Bureau (CFPB).

3. Ask about costs. Once you’ve zeroed in on a debt settlement company, inquire about how much it charges for debt settlement. If the company skirts your questions about costs, this may signal that it’s a shady operation. Debt settlement companies typically charge a 15% to 25% fee to tackle your debt; this could be a percentage of the original amount of your debt or a percentage of the amount you’ve agreed to pay. Let’s say you have $10,000 in debt and settle for 50%, or $5,000. On top of the $5,000, you could be required to pay another $750 to $1,250 in fees to the debt settlement company.

4. Review your finances. Debt settlement companies frequently require you to put money into a special savings account for 24 months or longer before the debt is completely settled. These payments go toward the lump-sum settlement of your debt. In some cases, you may find it hard to keep up with these payments. Therefore, you might give up on the settlement agreement before all or some of your debt is cleared. To avoid this scenario, go over your budget to see whether you’d be able to afford debt payments for 24 months or more.

5. Inquire about the timetable. It often takes two to four years to complete the debt settlement process. Over that time, you may accumulate interest and fees charged by the creditor, in addition to the fees charged by the debt settlement company. Why might you be hit with interest and fees by a creditor? Because debt settlement companies often suggest that you stop making payments to your creditor while you’re working with a settlement company and, instead, shift that money to a special savings account. Be aware that if you’ve halted payments to your creditor, you may be contacted by debt collectors or may even be sued.

6. Select a debt settlement company. If you’re fully aware of the potential pitfalls and ready to move ahead with debt settlement, it’s time to pick a debt settlement company based on your research.

7. Nail down the details. Before doing business with any debt settlement company, make sure you’re clear about the timetable and the fees. Also, ask how many of your initial payments will go toward the company’s fees, and how much money you’ll end up paying over time.

8. Know the tax consequences. The IRS views any forgiven debt as taxable income if it exceeds $600. So, if you settle a $10,000 debt for $5,000, the $5,000 that was forgiven likely will be taxed.