If you are in debt and cannot pay your bills, is a debt settlement program the cheapest way out of debt? You might draw that conclusion from the American Fair Credit Council (AFCC), an industry association of companies operating in the debt settlement industry that have agreed to a strict code of conduct.

Key takeaways from the 2020 report include that debt settlement provided, on average, $2.64 in consumer savings for each $1.00 fee assessed, and that nearly all offered settlements, over 98 %%, resulted in a decrease of the client’s debt that was greater than the accompanying fees.

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

Still, is debt settlement the cheapest way to emerge from debt? Let's take a closer look.

Key Takeaways

  • Debt settlement involves offering a lump-sum payment to a creditor in exchange for a portion of your debt being forgiven.
  • To successfully negotiate a debt settlement plan, it is important to stop minimum monthly payments on that debt, which will incur late fees and interest and damage your credit score.
  • Typical debt settlement offers range from 10% to 50% of what you owe.
  • The longer you allow debt to go unpaid, the greater your risk of being sued.
  • Creditors are under no obligation to reduce your debt, even if you are working with a reputable debt settlement company.

What Is Debt Settlement?

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. 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.

Consumers can settle their debts or hire a debt settlement firm to do it for them. In the latter case, you’ll pay the firm a fee that’s calculated as a percentage of your enrolled debt. Enrolled debt is the amount of debt you have when you enter the program. By law, the company can’t charge this fee until it has 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.

According to AFCC data put together by Freedom Debt Relief, one of the country’s most prominent debt negotiators, 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
Freedom Debt Relief, Data provided by American Fair Credit Council.

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

Debt settlement will most likely have a negative impact on your credit score.

Debt Settlement Strategies and Risks

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 the 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 credit report for up to seven years.

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 (CFPB) 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.

Debt Settlement vs. Bankruptcy

When the process works as intended, 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 non-exempt 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.” Still, he adds, “there may be a variety of reasons why chapter 7 may not be a good option. 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. “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 job loss, reduction in hours worked, medical expense, a death in the family, divorce, etc., and is struggling to make progress in paying down their debt.”

Chapter 7 bankruptcy can be over and done 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.


Make sure you can afford debt settlement. Many debt settlement programs may require you to deposit a specific amount of money into a specified savings account every month for 36 months or longer. Before you sign up for a program, make sure that you can afford to set up the required amounts for the entire length of the debt settlement program.

Debt Settlement vs. Minimum Monthly Payments

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, solid payment history is good for your credit score. However, we don’t recommend spending more than you have to on interest 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. The AFCC report cites that "the average client reduced their total debt at the time of settlement of approximately $30,000 to $35,000 by roughly $9,500 after deducting fees.

Consumer who consistently make just the minimum monthly payment on high interest credit card debt can end in paying more in interest than the principal.

Debt Settlement vs. Credit Counseling

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.

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 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 to make progress in paying down the debt." He continues: "Credit counseling and consolidation loans are appropriate for consumers with more modest financial stress on the spectrum of financial hardship. At the same time, 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.

Debt Settlement FAQs

What Percentage of a Debt is Considered in a Settlement?

According to a report from the Center for Responsible Lending, on average, debts are settled at 48% of the outstanding balance. However, the report also found that the balance increases 20% because of charges that the creditor might impose during negotiation for debt settlement.

How Do You Negotiate a Credit Card Debt Settlement Yourself?

The best way to negotiate a credit card debt settlement yourself is to call your lenders and ask them if you can be put on a plan to settle your debts. Some creditors will work with you, depending on your situation.

How Long Does Debt Settlement Stay on Your Credit Report?

A debt settlement stays on your report for seven years from its original delinquency date.

How Do You Find a Good Debt Settlement Company?

If you are looking for a good debt settlement company, you could ask your friends and family if they have any recommendations, ask your financial advisor, or look for online reviews. For example, Consumer Affairs magazine publishes a reliable list, and the Federal Trade Commission (FTC) offers information about both credit counseling and debt settlement companies.

What is a Debt Settlement Scam?

Unfortunately, debt settlement scams are not uncommon. For-profit companies claiming to "eliminate your debt" for a high fee may be scams. These charlatans will typically ask you to pay a high amount for their services but do little or nothing on your behalf. These companies may say they have ways to "fix" or remove adverse credit from your report, which is not possible to do.

In addition, a debt settlement scam can put you into even more debt if the company claims to have contacted your creditors, and they don't, leaving you to believe your debt is paid off. Always look up debt settlement companies online via the Better Business Bureau or your state's attorney general's office before signing up with one.

How Do You Repair Your Credit After Debt Settlement?

Debt settlement stays on your credit report for seven years, starting on the first date of your delinquency. In order to repair your credit after a settlement, it is important to not go over your credit limit, pay your bills on time, and make sure your debt to credit utilization ratio stays in balance.

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,” says Detweiler.