What Kinds of Debts Can Be Settled?

Debts that qualify for settlement commonly include unsecured debts, like credit cards, medical bills, personal loans and collection accounts. Ultimately, debt settlement eligibility hinges on the type of debt, the account status and whether the debt is backed by collateral. You also need a creditor that's willing to play ball.

Key Takeaways

• Unsecured debts are the most settle-friendly: Credit cards, medical bills, unsecured personal loans and collection accounts top the list of what kinds of debts can be settled, because lenders have no collateral to seize.

• Secured debts are rarely settled: Auto loans and mortgages are tough to negotiate because the lender can repossess your car or foreclose on your home to recoup what's owed.

• Tax debt may qualify through an IRS offer in compromise: This program can let you settle for less than the full amount if paying in full creates a financial hardship — but approval isn't guaranteed.

• Some debts can't be settled at all: Bankruptcy and creditor negotiation generally won't erase child support, alimony, most taxes or most student loans, since these are governed by court orders or federal rules.

• Settlement carries real costs: Missed payments and settled-for-less accounts can damage your credit, and forgiven debt is often treated as taxable income you must report.

• Negative marks stick around: Most negative information can stay on your credit report for up to seven years, so weigh the long-term credit impact before you settle.

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What Debts Are Usually Eligible for Settlement? 

Creditors are generally most willing to settle unsecured debts — namely, outstanding balances that aren't backed by collateral, like a home, car or other financial asset. That’s because, if there's no asset claim, they’re at risk of recouping nothing, and so prefer to accept at least some of what you owe. 

Unsecured, “settlement-friendly” debts include:

• Credit cards

• Medical bills

• Unsecured personal loans

• Lines of credit

• Private student loans

• Collection accounts

• Tax debt — through IRS or state tax settlement programs

Still, settlement eligibility doesn't guarantee approval. A creditor can and simply may refuse to settle, ask for an unaffordable lump-sum payment, or offer only a small reduction.

What Debts Qualify for Debt Settlement? A Quick Comparison

Why Some Debts Are Easier to Settle Than Others

Unsecured Debts Are Usually More Flexible

Unsecured debts aren’t backed by property, so recouping most or all of the funding isn't guaranteed. If a creditor or collector senses they won't receive the total outstanding amount, they may settle for less than they're owed to avoid fully absorbing the loss.  

Can Secured Debts Be Settled?

Lenders have clear recourse with secured debts — they can seize the collateral — for instance, repossessing a vehicle or initiating foreclosure proceedings on a home — to recoup all or a large portion of what’s owed.

That makes settling these accounts quite difficult. You might be able to mitigate repossession or foreclosure through loan modifications, hardship programs or other mortgage relief.    

Why Delinquent and Collection Accounts May Be Treated Differently

Account status plays a role in debt settlement eligibility. Some lenders, for instance, won’t negotiate until a loan is seriously delinquent, charged off or in default. That timeline varies by creditor and debt type, but generally occurs after payments are 30 to 180 days past due.      

That doesn't mean you should stop making payments. A settlement isn't guaranteed, and each missed payment may do big damage to your credit score, as will charge-offs, defaults, new collection accounts and other missteps related to delinquency. 

Plus, penalty interest, late fees and other charges are likely to accrue and increase your existing debt burden. 

What To Check Before Trying to Settle a Debt

If the debt is still “owned” by the original creditor, you'll need to negotiate with them. If that creditor has sold the debt to a collection agency, you'll need to negotiate with the collector.

You can usually confirm who “owns” a debt by calling the original creditor, checking account entries on your credit report or requesting legally required written verification from any collector that contacts you.

What Settling a Debt Could Cost You

Debt settlement may reduce what you owe and help you get out of the red faster, but it carries these major tradeoffs:

• Credit score impact: Settling a debt for less than the balance may show up on your credit report and damage your credit score. So will any missed payments, defaults and charge-offs – sometimes recommended by debt settlement companies as a negotiation tactic — related to open accounts.   

• Settlement fees: A debt relief company may often charge 15% to 25% of your total enrolled debt for the service. Plus, interest and fees can continue to accrue on outstanding balances during negotiation.

• Tax consequences: The IRS considers many forgiven debts as taxable income you must declare on that year’s tax returns.

• Collection efforts, including lawsuits: Attempting to settle a debt can sometimes encourage creditors to ramp up collection attempts, including lawsuits, judgments and garnishment, to recoup all or a larger portion of the outstanding funds. 

• Lump-sum payment requirements: Creditors are often more willing to settle a debt if you offer to make an immediate lump-sum payment, which could negatively impact your cash flow and savings.  

Before You Pay, Get the Settlement Agreement in Writing 

A verbal agreement is encouraging, but provides little to no legal cover. Both the Consumer Financial Protection Bureau (CFPB) and the Federal Trade Commission (FTC) suggest getting all settlement terms in writing to prevent disputes. 

A strong written debt settlement agreement includes:

• Name of the settled account

• Agreed-upon final amount, including principal, fees and interest

• Amount of debt that’s been forgiven

• Payment due date(s)

• Date the debt is or will be considered fully satisfied

• Whether and when collection efforts will stop

• Any credit reporting commitments made by the creditor — uncommon, but possible

Debt Settlement Alternatives to Consider

If you’re dealing with debt, settlement isn’t your only option. Depending on your situation's severity and complexity, you could alternatively pursue: 

• Credit counseling: Nonprofit credit counseling agencies offer free budgeting and money management advice to help borrowers make monthly payments and more readily eliminate their debt loads.  

• Debt management plans (DMPs): For a (relatively) nominal fee, these agencies will also negotiate with your creditors to consolidate multiple debts into one monthly payment, sometimes with fewer fees or lower interest.

• Debt consolidation: Depending on your credit, you might qualify for a top debt consolidation loan or balance transfer credit card that you can use to pay off and consolidate pricey debts into a single monthly payment. 

• Creditor hardship programs: Issuers, lenders and sometimes debt collectors may allow you to defer payments, lower monthly minimums or pause fees and interest.

• Legal guidance: An attorney can help you better understand if bankruptcy is worth pursuing. 

Final Take

If you have an overwhelming amount of unsecured debt, like credit cards, medical bills or personal loans, debt settlement through direct negotiation or a for-profit company is an option.

But the type of debt you haven't isn't the only factor. There are trade-offs to consider, including fees, the fact that results aren't guaranteed and any negative impact to your credit score.        

FAQs

Can a debt be settled if it is already in collections?

Yes, a debt can be settled if it's already in collections. In fact, collectors are sometimes more willing to negotiate than other creditors, at least over unsecured debts, as they buy accounts that are at serious risk of nonpayment, often for pennies on the dollar.

Can medical debt be settled?

Yes, medical debt can be settled with the healthcare provider or a collector they sold a debt to. Sometimes hospitals and doctors offer financial assistance or hardship programs to indebted patients.

Can secured debt ever be settled?

It's not impossible to negotiate at least some part of a secured debt — like, for instance, if you still have a balance on your auto loan — but it’s much more difficult to do so, given the lender has a claim to the underlying asset. 

Does settling a debt remove it from your credit report?

No, settling a debt doesn't automatically remove it from your credit report. Negative income can generally stay on file for up to seven years. However, its effects lessen over time, and your score could benefit from settling a collection account, in particular, as newer credit scoring may treat unpaid collections more severely than paid ones.

Key Terms

• Debt settlement: Negotiating with a creditor or collector to accept a lump sum or reduced amount that's less than the full balance you owe, which then settles the account.

• Unsecured debt: Debt not backed by collateral, like credit cards, medical bills and most personal loans — generally easier to settle because the lender has no asset to seize.

• Secured debt: Debt tied to property, like an auto loan or mortgage, where the lender can repossess or foreclose if you don't pay.

• Charge-off:When a creditor writes off your debt as a loss after several missed payments, typically around four to six months past due — you still owe the balance, and it can hurt your credit further.

• Deficiency balance:The gap between what you owe and what the lender recovers after selling repossessed property, which the lender may try to collect or sue over.

• Offer in compromise: An IRS program that may let you settle federal tax debt for less than the full amount when paying in full isn't possible or creates hardship.

• Time-barred debt:Old debt past the state statute of limitations, meaning a collector can no longer sue you to collect, though the debt may still exist.

• Canceled debt:A forgiven or discharged balance you no longer have to pay, which the IRS generally treats as taxable income reported on a Form 1099-C.

Sources

• FTC — How To Get Out of Debt: Explains debt settlement, debt management plans, which debts can't be discharged and the risks of for-profit programs.

• CFPB — How long does information stay on my credit report?: Confirms most negative information can be reported for up to seven years.

• IRS — Offer in Compromise: Details how taxpayers may settle federal tax debt for less than the full amount owed.

• IRS — Topic No. 431, Canceled Debt: Covers when forgiven debt counts as taxable income.

• FTC — Vehicle Repossession: Explains repossession, deficiency balances and negotiating with auto lenders.

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