“Debt settlement on average saves consumers $2.64 for every $1 in fees paid,” boasts a report released last month by the American Fair Credit Council, an industry association of companies operating in the debt settlement industry that have agreed to a strict code of conduct.

The AFCC-commissioned report is based on a study of 400,000 consumers with 2.9 million accounts enrolled in debt settlement programs from Jan. 1, 2011, through March 31, 2017, and was created by national certified public accounting firm Hemming Morse LLP. The report also states that “more than 95% of debt settlement clients receive savings in excess of fees” and that most participants see their first account settlements within four to six months of starting the program.

“Debt settlement can save consumers money by allowing them to resolve their debts for less than the full balance,” says Gerri Detweiler, coauthor of the free Kindle eBook “Debt Collection Answers: How to Use Debt Collection Laws to Protect Your Rights.” “It can be a way out of debt for some individuals who can't afford to pay back the full amount they owe.”

But are debt settlement programs the cheapest way to get out of debt? Let’s find out.

Debt Settlement Savings and Costs

According to AFCC data put together by Freedom Debt Relief, the country’s largest debt negotiator, debt settlement is by far the cheapest option compared to credit counseling or making minimum monthly payments, as the infographic below shows.

Infographic with information about the savings provided by debt settlement

Whether debt settlement will be the least expensive option for you, however, depends on the specifics of your situation.

Debt settlement, also called debt relief or debt adjustment, is the process of resolving delinquent debt for far less than the amount you owe by promising the lender a substantial lump-sum payment. Consumers can settle their own debts or hire a debt settlement firm to do it for them. Depending on the situation, debt settlement offers might range from 10% to 50% of what you owe; the creditor then has to decide which offer, if any, to accept.

Ironically, consumers who enroll in a debt settlement program because they can’t manage their debt burdens– but who have still been making payments, even sporadic ones – have less negotiating power than those who have made no payments. So their first step must be to stop making payments altogether. “Credit scores can suffer during the debt settlement process, particularly at the beginning,” says Sean Fox, co-president of Freedom Debt Relief. “As the consumer begins to make payments on settled debt, credit scores typically will recover over time.”

Becoming delinquent on debt and settling debt for less than you owe can have a severe impact on your credit score – likely sending it into the mid-500s, which is considered poor. The higher your score before you fall behind, the larger the drop. Late payments may remain on your report for up to seven years. (For more, see The 5 Biggest Factors that Affect Your Credit and How will debt settlement affect my credit score?)

Making no payments also means accumulating late fees and interest, which add to your balance and will make it harder to pay off your debt if you can’t settle. Consumers can expect harassing debt collection phone calls once they become delinquent. Creditors might also decide to sue consumers for debts above $5,000 – debts that are worth their trouble, in other words – which can result in wage garnishment. “The more money you have available to settle, the sooner you can resolve the debt. The longer your debt goes unpaid, the greater the risk of being sued,” Detweiler says.

There are no guarantees that after incurring this damage, the lender will agree to a settlement or that it will agree to settle the debt for as little as you’d hoped. Chase, for example, will not work with debt settlement firms. It will only work directly with consumers or with nonprofit, licensed credit counseling agencies that help consumers. The Consumer Financial Protection Bureau cautions that the accumulated penalties and fees on unsettled debts could cancel out any savings the debt settlement company achieves for you, especially if it doesn’t settle all or most of your debts.

When a third party company negotiates and settles debt on your behalf, you’ll pay it a fee that’s calculated as a percentage of your enrolled debt. Enrolled debt is the amount of debt you come into the program with. By law, the company can’t charge this fee until it has actually settled your debt. Fees average 20% to 25%.

Debt settlement may also entail tax costs. The Internal Revenue Service (IRS) considers forgiven debt to be taxable income. If, however, you can demonstrate to the IRS that you are insolvent, you will not have to pay tax on your discharged debt. The IRS will consider you to be insolvent if your total liabilities exceed your total assets. It’s best to consult a certified public accountant to determine if you qualify for insolvency status.

Bankruptcy Savings and Costs

When the process works as intended, MarketWatch points out, debt settlement can benefit everyone involved. Consumers get out of debt and save money, debt settlement firms earn money for providing a valuable service, and creditors receive more than they would if the consumer stopped paying altogether or entered chapter 7 bankruptcy. Chapter 7 bankruptcy involves liquidating the debtor’s nonexempt assets and using the proceeds to repay creditors. Exempt assets vary by state, but often include household and personal possessions, a certain amount of home equity, retirement accounts and a vehicle.

Compared to debt settlement, Detweiler says, “if a consumer is eligible for chapter 7 bankruptcy, it may be a faster option. It is a legal process that can stop collection calls and lawsuits. Debt settlement doesn't offer those guarantees.

“But there may be a variety of reasons why chapter 7 may not be a good option,” Detweiler adds. “A consumer may have to surrender property they may feel they need to keep. Or they may not want their financial troubles to be a matter of public record.”

Consumers could also find their employment options limited if they declare bankruptcy, as some professions evaluate workers’ credit histories. Another problem many indebted consumers face is not being able to afford a bankruptcy attorney.

Further, “many consumers cannot qualify for bankruptcy protection,” Fox says. “In contrast, debt settlement is available to any consumer who can demonstrate a financial hardship such as a loss of job, reduction in hours worked, medical expense, death in the family, divorce, etc. and is struggling to make progress in paying down their debt.”

But in terms of time, chapter 7 bankruptcy can be over and done with after three to six months, versus years for debt settlement. It can be less stressful and may allow your credit score to recover faster, though bankruptcy will remain on your credit report for 10 years.

Minimum Payment Savings and Costs

Making minimum monthly payments on high-interest debt is not a good option for consumers who want to save money. It can take years – decades, even – depending on how much debt you have and what the interest rate is. Interest compounds every day on your entire balance, and with minimum payments you make little progress paying your balance down each month.

Consistently making minimum monthly payments and forking over tons of interest might make you highly profitable to your creditors, and, yes, a solid payment history is good for your credit score. However, we don’t recommend spending more than you have to on interest just to boost your credit score. A good credit score won’t pay for your retirement; money in the bank will. Further, if the amount of available credit you’ve used is high relative to your credit line, that will hurt your credit score and potentially negate the effect of your consistent, timely payments.

As the AFCC report points out, the average consumer who enrolled in a debt settlement program had $25,250 in debt, most of which was credit card debt. If these customers only made monthly minimum payments of $600, they would pay nearly $60,000 over about 36 years, $34,000 of which would be interest, before their debt was wiped out.

Credit Counseling Savings and Costs

Credit counseling is a free or inexpensive service provided by nonprofits and government agencies. Interestingly, these services are often partly funded by credit card companies. By enrolling in a debt management plan with a credit counseling agency, you may receive an interest rate reduction on your balances and a waiver of penalty fees. (For more, see Credit and Debt Management: Credit Counseling.)

Those concessions may or may not be sufficient to help you pay down your debt considerably faster, and you may or may not be able to afford the new required monthly payments. In addition, you may not qualify for an interest rate reduction, even if you have a significant financial hardship.

However, because you won’t have to default on your debt, your credit score may suffer less. Also, credit counseling may offer additional financial assistance that can help you avoid similar problems in the future, such as budget development and financial counseling, and referrals to low-cost services and assistance programs to help you reduce your expenses. Fox says a credible debt settlement company will also work with clients to help them learn how to budget, use credit responsibly and live within their means.

So how do you know which to choose, if you don’t want to pursue bankruptcy? “Credit counseling is best suited for consumers who have $2,500 to $15,000 worth of unsecured debt and simply need a reduction in their interest rate in order to make the monthly payments manageable,” Fox says. “Debt settlement, on the other hand, generally works well for consumers who have more than $15,000 in credit card debt and who need a reduction in the actual principal owed in order to make progress in paying down the debt. On the spectrum of financial hardship, credit counseling and consolidation loans are appropriate for consumers with more modest financial stress, while debt settlement and bankruptcy help those who have more significant financial stress.”

The Federal Trade Commission website has helpful information about how to choose a credit counselor. The National Foundation for Credit Counseling is another good resource.

The Bottom Line

Debt settlement may indeed be the least expensive way to get out of debt for many consumers. It depends in part on how much you owe, and there are other factors to consider, too, such as how much time it takes and how stressful you might find it compared with the alternatives. It’s important to fully understand the pros and cons of debt settlement before you choose it.

The best approach is to research all three options. “If you are struggling with debt, talk with a credit counseling agency, a debt settlement expert and a bankruptcy attorney so you understand your various options and make an informed decision,” Detweiler says. (For more, see A Guide to Debt Settlement.)