Settlement

Settlement summary: 

• Debt settlement is the process of negotiating with creditors to reduce the amount you owe.

• Typically, a company helps you reach a deal with your creditors. You can also try to negotiate an agreement on your own.

• Debt settlement companies can’t charge you upfront fees or guarantee to eliminate debt.

Debt Settlement Definition and Meaning

Debt settlement is the process of negotiating with creditors to reduce the amount you owe. You can negotiate a debt settlement agreement on your own, or you can work with a third-party company to negotiate on your behalf. Debt settlement (sometimes called debt relief) comes with some risks, but it can also offer a pathway out of debt and an alternative to bankruptcy.

How Debt Settlement Works

Debt settlement involves negotiating with creditors to pay a lower amount than you owe, sometimes in a lump sum. Typically, you’ll deposit money into a designated savings account each month. Once you’ve built up enough savings for the settlement company to make offers, the company will start to work out agreements with your creditors.

Some debt settlement companies will suggest that you stop making payments so that they’ll have more leverage when they negotiate. This may accomplish two things: demonstrating to the creditor that you can't afford to repay the entire balance, and making more money available to stash in your debt relief savings account. 

If they suggest that you temporarily halt payments, they’ll also need to tell you about the repercussions of not making payments. These can include damage to your credit score and the potential for higher interest and fees.

Debt settlement companies charge a fee for their services. A typical fee is 15% to 25% of the amount the company is settling, sometimes called the "enrolled debt." It’s illegal for a settlement company to charge you an upfront fee.

If you’re comfortable negotiating, you could bypass a debt settlement company and try to work out an agreement directly with creditors. Some creditors and lenders will offer a workout agreement if you’re behind on payments, where they agree to a lower interest rate or minimum monthly payment to help you get back on track.

Debt Settlement vs. Debt Management Plan vs. Debt Consolidation

Debt settlement, debt management plans, and debt consolidation are all options to consider if you’re struggling with bills. They may sound similar, but the type of relief they offer is quite different.

• Debt settlement. You or a debt relief company negotiates with your creditors with the goal of getting them to accept an offer for less than you owe.

• Debt management plan (DMP). A credit counseling organization (usually a nonprofit organization) works out a plan where you make a single payment to the organization, which then distributes it to your creditors. DMPs may lower your monthly payment, often by extending your repayment timeline, but they typically don’t lower the amount you owe.

• Debt consolidation. With debt consolidation, you take out a loan to pay off multiple debts, ideally at a lower interest rate. If you qualify for a debt consolidation loan, you’ll often save money with a  lower interest rate while also simplifying your finances. As with a DMP, debt consolidation doesn’t reduce the amount you owe.

Red Flags to Watch for If You’re Considering Settlement

Debt settlement is an option for improving your financial situation when you’re overwhelmed with bills. Unfortunately, there are some unscrupulous settlement companies. Here are some red flags to watch out for if you’re considering debt settlement. The company:

• Charges upfront fees.

• Guarantees that it can reduce your debt by a certain percentage or wipe out debts altogether.

• Claims there’s a new government program to eliminate credit card debt.

• Promises it can make debt collection efforts stop.

Debt settlement isn’t a quick fix—it’s a long-term process. Avoid any company that makes guarantees or promises it can make your debt disappear overnight.