Should You Settle Your Credit Card Debt?

If you’re struggling with credit card debt and are looking for ways to get relief, you might be considering debt settlement. Debt settlement involves negotiating with your current creditors to reduce how much you owe by a certain percentage.

Debt settlement can alleviate your financial burden, but it’s not without risk. It’s not guaranteed to work, for one thing. It can also have a far-reaching impact on other aspects of your life, including your credit.

Here’s what you need to know about this form of debt relief and when you might (or might not) want to choose it.

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Key Takeaways

• Debt settlement means paying less than you owe. You or a company negotiate with creditors to accept a lump sum below the full balance, with the rest forgiven — but it's never guaranteed.

• Only unsecured debt qualifies. Credit cards and personal loans are eligible; secured debts like mortgages and auto loans generally aren't.

• Companies can't charge upfront. Under the FTC's Telemarketing Sales Rule, a for-profit settlement company can't collect a fee until it settles a debt and you've made a payment on it.

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How Does Debt Settlement Work? 

Debt settlement is a process, not an immediate (or even guaranteed) solution. You can take a DIY approach or you can work with a company that handles things for you.

Here’s how debt settlement generally works:

1. List out all your debts. This can help you determine exactly how much you owe and to whom.

2. Separate unsecured from secured debts. Generally, only unsecured debts (like credit cards and personal loans) are eligible for debt settlement. Secured debts (like mortgages or auto loans) aren’t.

3. Come in with a plan. Know why you need to settle your debts and approximately how much you want to settle them for. Be ready to provide clear, honest information about your financial situation to support your case. It will help with DIY negotiations.

4. Stop paying the bill. If you go through a debt settlement company, they might advise you to intentionally stop making payments on the accounts you want to settle. Creditors want to get paid, so ceasing payments could make them more willing to work with you. The trade-off is late fees and damaged credit.

5. Save up for a lump-sum payment. When you work with a debt settlement company, you’ll be asked to deposit funds into a secured savings account each month until you’ve reached a predetermined amount.

6. Negotiate with your creditors. Contact your creditors one at a time to see if they’d be willing to reduce what you currently owe. Some will say yes, while others will refuse.

7. Pay off your debt. If a creditor agrees to settle a debt, you’ll generally need to pay the new amount in a lump sum. Use the amount you’ve been saving to do this.

8. Rinse and repeat. Repeat this process for each outstanding debt you’re trying to settle.

Throughout the process, get everything in writing. That way you’ll have it for your records in case there are any legal concerns or questions down the road.

Keep in mind that debt settlement isn’t a quick process. It can take months to settle a single debt. If you have multiple debts, it could take anywhere from two to four years.

Also, debt settlement companies charge for their services. Fees range from around 15% to 25% of the amount you originally owed (not the settled amount).

Say you owe $10,000. The company might charge $1,500 to $2,500. You won’t have to pay until the debt is officially settled (it's illegal to charge fees upfront), but that can take a hefty chunk out of any “savings” you might have had. Settling your debts on your own can save you quite a lot of money in a case like this.

What Are the Pros of Debt Settlement? 

Debt settlement isn’t always the right solution, but there are some advantages to doing it, like:

• Reduce your outstanding credit card (or other unsecured) debt

• Potentially quick relief from overwhelming amounts of debt

• Could keep you from being sued for unpaid debts

• Debt won’t go to collections

• Could be a better alternative to bankruptcy (not always)

What Are the Cons of Debt Settlement? 

Every form of debt relief comes with its potential drawbacks. These are the big ones for debt settlement:

• Not a guaranteed process

• Debt settlement companies usually charge 15% to 25% of your original outstanding debt

• Most companies won’t work with you if you owe less than $10,000

• Can seriously damage your credit (and make it harder to qualify for new credit)

• You may owe taxes on the forgiven amount (you'll receive form 1099-C)

• Ceasing payments means growing late fees and interest charges, which you might need to pay

• Usually takes two to four years

How Do You Know if Debt Settlement Is Right for You? 

Debt settlement might be the right call if:

• You’re drowning in unsecured debt (including credit cards)

• You owe a large amount (and can justify company fees) or can settle your debts yourself

• Your credit is already severely damaged

• Your estimated savings far outweigh any fees or accruing interest charges

Alternatives To Debt Settlement

Debt settlement isn’t your only option, nor does it always work. Fortunately, you do have other avenues to consider, including:

• Debt consolidation: Take your unsecured debts and combine them into one loan. You’ll be left with a single monthly payment and a potentially lower interest rate. If you get a longer repayment term, you could also lower your monthly payments.

• Balance transfer card: These cards often come with a 0% or low-interest introductory period. See if you can transfer your existing cards’ balances onto the new card. This works best when you have good credit and can pay off the transferred balance within the intro window.

• Debt management plan (DMP): Credit counseling companies can help you take back control over your finances. They can also set up a repayment plan for your debts. You’ll still need to repay what you owe, but in a more manageable way. Credit counseling is also generally low-cost or even free.

Since debt settlement can be risky, you might want to consult a credit counselor or attorney about your options. They can help direct you so you choose the one that’s best for you.

FAQs 

What are the biggest risks of debt settlement?

Not every debt settlement company is legitimate, and fees can be high. There also aren’t any guarantees that it’ll work. If it doesn’t, and you’re not making your monthly payments, you could end up with hefty interest charges and late fees by the end. This means more debt and damaged credit. You may also owe income tax on the settled amount.

How long does debt settlement usually take?

It depends on how you go about it and how many debts you’re settling. Expect it to take around two to four years.

How much can you typically settle debt for?

Legitimate debt settlement companies don’t make guarantees. It’s also possible that you won’t be able to settle at all. When successful, however, you could reduce your original credit card debt by anywhere from 30% to 80%.

How can I find a legitimate debt settlement company?

Look for ones that have positive reviews on trusted sites like Trustpilot or the Better Business Bureau. Check what other customers are saying and what types of complaints exist. A legit company will resolve those complaints quickly. They also won’t charge you upfront fees or make guarantees.

Which debts don’t qualify for settlement?

Secured debts rarely qualify for debt settlement. This includes any debt tied to an asset, like an auto loan or mortgage.

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Key Terms

• Debt settlement: Negotiating with creditors to accept less than the full balance owed, with the remainder forgiven once you pay the agreed amount.

• Unsecured debt: Debt not backed by collateral, like credit cards and personal loans — the type eligible for settlement.

• Lump-sum payment: A single payment, usually saved up in a dedicated account, used to settle a debt at the reduced amount.

• Enrolled debt: The total balance you place in a settlement program, on which the company's fee is typically based.

• Telemarketing Sales Rule (TSR): The FTC rule barring for-profit debt relief companies from charging fees before settling a debt and securing your first payment.

• Form 1099-C (Cancellation of Debt): The IRS form a creditor files when it forgives $600 or more, which may make the forgiven amount taxable.

• Statute of limitations: The limited window during which a creditor can sue to collect a debt; it varies by state.

• Debt management plan (DMP): A nonprofit-administered alternative that repays the full debt at a negotiated lower rate over three to five years.

Sources

• FTC — Debt Relief Services & the Telemarketing Sales Rule

• CFPB — What is debt settlement / a debt settlement program?

• NFCC — What Is Debt Settlement?

• IRS — Topic No. 431, Canceled Debt

Summary generated by AI, verified by MoneyLion editors