What Is a Debt Settlement? A Simple Technique to Negotiate

Last updated on June 17th, 2023 at 06:31 pm

In this article, you’re going to learn what is a debt settlement and how it works. 

Paying debt is a serious issue. You need to make on-time payments including interest and principal amount. But if you get late on your payments you need to face a decrease in your credit score and trust in the lender.

On the other hand, high-interest credit cards and student loans are very difficult to pay back. The interest amount compiles very fast and most people haven’t enough money to make payments. 

Here most consumers don’t know how to through this burden while saving money. But there is a solution to it called debt settlement.

That’s what you’re going to cover in this post step by step. 

So let’s have a look at the exact breakdown. 

What is a debt settlement? 

Debt relief is one of the strategies for getting out of debt.

It is referred to as the arrangement between the debtor and creditor to settle the debt for less than what is originally outstanding. 

In simple words, a borrower pays the lender less than what he is liable to pay and the lender considers that amount as full. After that, the lender writes off the whole debt. 

It is one of the cheapest ways for a borrower to get out of debt. 

According to American Fair Credit Council (AFCC) report on debt settlement, 95% of the clients saved money after paying fees. On the other hand, for every $1 paid in fees, the consumer saves $2.64.

Cumulative percentage of clients achieving first debt settlement by month
Source: American Fair Credit Council

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What are the types of debt settlement?

There are two main types of debt settlement. One is called DIY debt settlement and the second is called Professional debt settlement

1. DIY or Do-It-Yourself debt settlement

In a DIY or do-it-yourself debt settlement strategy, the borrower personally communicates with the lender to settle his debt. He discusses his problems and tries to convince the creditor to settle his debt. 

This strategy is so beneficial. Because you don’t need to pay any extra cost or fee to any third-party debt settlement professional or company. This way you can save a lot of money. 

But on the other hand, everyone can’t do this. Because you need to act strategically to convince the lender that you really deserve debt relief. You must have to present your financial situation as worse as possible so the lender gets in fear of losing all of his money. 

Along with that, you should have confidence. Without confidence, it is very difficult to persuade creditors to settle the debt. 

2. Professional debt settlement

Here you don’t negotiate directly with your creditor. Here you include a third party called a debt settlement company. The company then contacts your lender on your behalf of you to negotiate the debt. 

This strategy is a good choice if you can’t deal with such things yourself. Professionals in these companies have years of experience and usually know multiple lenders. So there is a higher chance that your lender agrees to settle your debt.

You need to pay them a fee. It is usually 15% to 40% of your overall debt amount. For example, if they settle a $10,000 debt for $5000 you need to pay a $2500 or $3000 fee to a debt relief company.

In this post, you’ll learn mostly about debt settlement through third-party companies.  

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How does debt settlement work?

Now let’s understand how the process of debt settlement work with details and example.

Sometimes consumers spend a lot of money with their credit cards or they take other unsecured loans for personal needs. If their income is low or anything unfavorable happens like business loss or job loss, or illness then it becomes difficult to make debt payments. 

In this situation, the consumers contact a debt relief company to make an arrangement with their lender and settle the debt.

From here onwards the steps are mentioned below which a consumer use actually to settle his debt. 

The consumer contacts a debt relief company and discusses his problem. 

Then he follows some rules like he doesn’t make payments to the lender but instead to an escrow account with his own control for a specific time frame like 24 to 36 months. 

When a handsome amount of money is accumulated, then the settlement company starts contacting his lender. They try to make a profitable arrangement while discussing the situation of the borrower.

If the lender agrees to write off the whole debt for a specific deal then congratulations your debt is paid off. 

This method can be used for single debt or multiple ones. And negotiation can be performed with multiple creditors.

Understanding with example

For example, you’ve five credit cards. 

  • Credit card A 7,000
  • Credit card B 5,000
  • Credit card C 10,000
  • Credit card D 6,500
  • Credit card E 2,500

You want to settle down credit card C debt for less than the actual amount of $10,000. Suppose you’re currently making a monthly payment of $250 each month. 

Now you contact a debt settlement company. And they require you to stop making the monthly payment to your creditor and make it to them for 24 months. 

When 24 months are completed then you’ve accumulated $6000 to the settlement company. 

The settlement company will contact your lender to settle the $10,000 amount. For example, if a lender agrees on $4500 then this amount is considered full. And the lender signs the written agreement and writes off your debt.

The remaining 1500 is charged as a fee by the debt relief company. Remember that these companies don’t charge you any fee until they settle the debt. And don’t take any advance as well. If they get successful then they charge you a fee. 

So this is the simple breakdown of how debt relief works and you get out of debt. Now you have a good understanding of what is a debt settlement and how it works. 

Let’s jump to the next section.

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What is a debt settlement payment plan?

Another thing that matters in debt settlement is how you pay the settled money to your lender. 

There are two main methods in which one is paying a lump sum amount in full and the other is paying in installments.

It is possible that your lender wants you to pay a settlement amount like $5000 for the $10,000 debt in the above example, in full. This way the lender doesn’t wait for many months to actually take the money but instead he is getting a lump sum immediately. 

Here it is beneficial for lenders but you need to take a burden and you must have to arrange that amount. In case your financial situation is between hard and rocks then it can be difficult to accumulate. 

The second method is that you pay the lender in the form of installments over a period of time. In this method, you will pay slowly in easy installments. But here also you need to make payments on time. Therefore the management is a bit higher. 

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What are the pros and cons of debt settlement?

Debt reduction is a cheap way to get out of debt if your creditor and settlement company can make a successful arrangement. But there are some pros and cons of using this method which you should consider before using this method. 

Pros of debt settlement:

  • It is a cheap way to pay off all your debt while saving money.
  • You can get out of debt fast while paying a small lump sum amount.
  • It decreases the mental stress created due to the debt burden.
  • No call from the creditor or a debt collector so no disturbance.
  • The creditor or collector can’t sue you for the settlement.
  • You can avoid other difficult methods like bankruptcy and consolidation.
  • It is a simple method. You don’t need to face any complex steps.
  • Its success rate is high usually more than 50% or even 80%.

Cons of debt settlement:

  • You may face penalties and extra fees for not making payments for a long time to your creditor. 
  • The creditor is not obligated to settle the debt and so he can sue you.
  • If the debt is settled the tax authority considers the savings as income and may impose the tax.
  • The negative impact on your credit report will diminish your credit score which is so difficult to improve. The data of VantageScore shows that if you settle a single debt your credit score can ding upto 45 to 130 points. Here is a breakdown of credit score range data from FICO and VantageScore.
Credit score ranges from FICO and VantageScore
Source: Forbes
  • A creditor may cancel all your credit cards and decline you as a client. 
  • You face difficulty in obtaining a loan because your trust and reputation is negatively impacted. 
  • There are chances of scams in settlement companies and your money can lose.
  • The creditor may handle your debt to the collection agency so you face dealing with him.
  • The time period it takes for settling the debt is so long. It usually ranges from 24 to 36 months and can go up depending on your situation.
  • In case you agree to give a lump sum amount in a short period of time, then it becomes difficult for you to accumulate that sum of money.
  • Debt settlement companies charge huge fees ranging from 25% to 50% of the total debt settled.

If you decided on debt settlement then don’t ignore these upsides and downsides so that you can make the right decision. Keeping them in mind not only helps you choose the right debt relief company but also helps you stay away from a lawsuit.

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How to negotiate debt settlement?

If you’re going to settle your debt yourself or using a settlement company there are some important points to consider. You’re required to follow these guidelines before even communicating with your lender for settling debt. 

Don’t make payments

Stop making payments to the lender. Start saving the money you pay to your lender so that you’ve accumulated a good sum of money to easily negotiate a deal.

Stop spending money

Don’t spend anything with your credit cards like going to restaurants, shopping malls, and purchasing luxury items. Instead, put it aside and spend nothing. This will present you to your lender as you’re in a very worst financial condition. And this can easily convince the lender to give you a competitive offer.

But if you do the opposite then it gives a signal to the lender that you’re avoiding debt obligation. He can sue you in court for doing this if the debt is more than $5,000. And if he wins the case the court may seize your property, saving accounts, or garnish your salary.

Do your research

Do enough research on debt settlement companies before choosing any. Compare them on the basis of turnaround time, fees, experience, and their terms and conditions.

Negotiate with lender

When all the requirements are fulfilled you contact the lender if you’ve good negotiation skills. Otherwise, hand over the task to your debt settlement company. 

While negotiating first start giving an offer of around 30% for the whole debt amount. But if the lender doesn’t accept it, you can offer up to 50% of the total amount due. But remember don’t go overboard. The reason is you don’t save any money.

The consumers save only 30% on the completion of debt settlement.

How much debt settlement consumers save
Source: Tight Finance

Sign the agreement

When your lender and debt settlement company agree then they sign a written agreement. If you negotiate yourself then don’t forget to sign a written agreement from the lender. The reason is there is no guarantee of verbal agreement. And it is possible that your lender hand over the debt to third-party debt collection agencies.

Now you have a deep understanding of how you go about negotiating the amount. If you follow these step-by-step processes then you can easily get a competitive offer that saves you lots of money.

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How to choose a debt settlement company?

You need to follow some tips if you want to settle your debt through professional companies. There are some simple tips that help you research the best company with a good record of previous performance. So here you go.


Verify the company and find out whether it is a registered corporation with a track record of performance. Contact the consumer protection bureau to get more information to know about any complaints or negative signals. You also find how much support they give to their customers. Don’t select any company which is bad at managing customer queries. 

You can contact your state attorney to find out about any lawsuit or action taken against the company. This will help you know if the company is real or fake. Search Google and read the customer’s and websites review written about the company. These reviews give you a clear picture of the company.

Turn around time

See how much time the company takes to settle the debt. This time period can range from 2 to 5 years. But it is good to go with that which completes the task within a given time. 

Do comparison

Compare different companies on the basis of fees. This is the most important step. Some companies charge more and others have a normal fee. Why do you take care of this step? Because the final savings you get depends on the fee a company charges you after settling your debt.

So choose the one with the lowest fee. Along with that don’t select any company which demands an advance fee or extra add-on fee. It is likely that these types of companies are just stealing more money from you and can be a scammer. 

Experienced management

The company must have an experienced management team with years of experience. The new debt settlement companies usually don’t have strong relationships with lenders, so they’re not good at settling debt. You need to choose one which has a track record of settling debt and has great results.

The performance of a debt settlement company is a major factor that determines the success rate of settling your debt. You also check that a company doesn’t work like a seller who sells your program to other companies but handles it from beginning to end by itself. This will keep your financial data secure. 

Follow these steps to choose the right company and get your debt settled on time. If you still don’t have much idea then you can read out this article from investopedia on the best debt settlement companies. This compares the company to different factors like fees, management plan, turnaround time, etc.

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How to avoid debt settlement scams?

The debt settlement industry is full of scammers like any other industry. If you want to stay away from these bullies then you should have clear guidance.

Here is what Federal Trade Commission for Consumer Protection says about these scams and you should read this article.

Source: Ferderal Trade Commisssion

The following tips will help you find the right debt settlement professional and avoid the risk of getting scammed.

  • Check out a company profile and confirm that it is a registered corporation. You can contact your state attorney and CPB for finding this information.
  • Read reviews about the company online to get an idea of how previous customers have experienced this company. If there are more negative reviews then don’t choose that company.
  • If any company demands an advance fee then don’t select that. According to law, the company can only charge a fee when the debt is settled.
  • If there are too many fees and any addon charges then don’t select that company. They are just stealing your money and you finally may not meet the goal for which you’re going to choose debt settlement. 
  • Make sure the company is not a seller of debt settlement programs and does its job on time. They should give you end-to-end service. If they don’t do this then select any other. 

Keep in mind these steps while choosing your company. This will help you avoid scammers and any monetary loss which can get you into more debt.

What is a debt settlement alternative?

Debt settlement is not the only way of getting out of debt. There are some related options that you can choose to eliminate your debt fast. Some common ones include the following.

Debt consolidation

In debt consolidation, you pay the existing debt with new debt at a low-interest rate. For example, if you’ve five credit cards with a combined debt of $25,000 and an average interest rate of 18%, you can take a new loan at 12% to pay it.

This will not only help you pay the debt fast but also save money on interest. There are different consolidation methods including balance transfer, personal loan, home equity loan, and credit counseling.

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Minimum monthly payments

In this method, you make the minimum payments on your credit card debt. This will help you pay the loan in the long term while keeping your balances high on the credit card. But if you want to save for retirement and have a low income then don’t go for this method. The reason is it is the most costly method and you pay a large amount in interest.

Credit counseling

These are companies that provide financial education. They have experienced and trained employees who help you learn to make a budget, manage your debt, pay down your debt, and give workshops. These are good for learning the ins and outs of financial management. But at the same time, these programs take a long time to complete and you still pay your debt 100% including interest. This option is good if you’ve $10,000 or less in debt. 


Bankruptcy is the last resort for getting out of debt. This option has many benefits over debt relief but at the same time is disadvantageous. If you come towards the benefits then filing bankruptcy will eliminate your debt and you become insolvent.

Under Chapter 13 your property is not ceased. On the other hand, if you come towards the downsides then it will ruin your credit score and the bankruptcy will stay on your credit report for 7 t 10 years. If you file bankruptcy under Chapter 7 then it is possible that your property is ceased paying the outstanding debt. You also face difficulty in taking future loans and jobs in any organization.

All these options have pros and cons. You must need to keep them in mind. But these are the best alternatives to debt relief as well. There are different consequences for which you can use each of these options. So if you’ve no knowledge then before utilizing them contact a professional financial consultant to get any advice.

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Frequently asked questions (FAQs)

Here are some important questions related to debt settlement:

What is a debt settlement program?

It is a method that a debt settlement company uses to settle consumers’ debts with creditors for less than the original amount due. These companies work for profit and consumers pay a fee ranging from 15% to 40% of the original debt amount. These companies are called debt settlements or debt relief companies.

What is a debt settlement agreement?

It is a written document in which the consumer promises to pay the set amount to the lender. This amount is less than the original amount of debt but when paid it is considered full and the debt is written off. This agreement is also called a debt compromise agreement.

What is a debt settlement fee?

It is a fee that the debtor pays to the debt settlement company. It is charged when the company actually delivers its service and settles the debt. No advance fee is taken because the law prohibits that. The fee usually ranges from 15% to 40% of the total debt amount. For example, if you owe $20,000 to the lender then if the fee is %15 your settlement company charges $3000.

How does debt settlement affect credit score?

Debt settlement negatively impacts your credit score is true. The reason is when you take debt the agreement is made between you and your lender that you pay back the whole amount. But when you settle the debt, you pay less than what is due and it violates the original agreement and makes changes to it. 

But the decrease in credit score depends on many factors. This includes your performance of other debts, credit utilization ratio, amount of debt settled, credit reporting system, and more. But normally as high, as your credit score is the more points you lose.  For example, if your credit score is above 720 then you may lose 140 to 160 points. 

According to data from VantageScore here is how you lose credit score points:

vantage credit score decrease for different reasons
Source: Super Money

When your credit score dings other lenders will worry about giving you credit. And it is likely that you face difficulty in taking future loans.

Is Debt Settlement Really Worth It?

Yes if your financial position is weak then it is a good decision. It will help you avoid declaring insolvency and getting late on payments. And in case there are hard days going on and it is impossible for you to pay off your debt then going for settlement using the cash on hand is a good choice to saving money.

How long does debt settlement stay on your credit report?

It stays on your credit report for 7 years. And during this time your credit score gets diminishes. The date starts from the day you settled the debt to the date 7 years complete. If you want to increase your credit score then you should cut down your spending and make sure your credit utilization ratio stays in balance. 

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Final thoughts

Debt settlement is a good option if you’re going through financial hardships and getting late on payments. It is the best option to choose for paying off your debt fast and saving money.

But at the same time, there are some bad things attached to it like a decrease in credit score, difficulty in taking a loan, and costs of settling debt.

That’s why you should discuss your financial concerns with a professional financial advisor to make the right decision.

I think after reading this whole guide you’re clear on what is a debt settlement and how it works. If there is a point or question you didn’t understand then tell me in your comments.

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Ahmad Ali