The Dangers of Debt Settlement

Understand potential downsides of debt settlement and what your options are

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Learn if debt settlement is, or is not not, the best solution to your debt. Photo:

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If you've fallen behind on your debt, you're not alone. In 2018, about 28% of consumers had a debt reported to a third-party collector, and 9% had at least one 60-day delinquency on a credit card, according to the Consumer Financial Protection Bureau. 

In the search for solutions, you might come across the term debt settlement. This is a process of negotiating debt terms with creditors. You can do this yourself, but it's often offered as a service by debt settlement companies as an alternative to bankruptcy or as a way to resolve a growing debt

Persuasive advertisements might promise you an easy way out of debt or a way to simplify your payments. But these services often tack on expensive fees, and they don't explain what potentially negative effects debt settlement can have on your credit score. 

Learn more about debt settlement and how it works, so you can make an informed decision that leaves you on solid financial footing.


If you're current on your accounts, or even just one or two months behind, and you want to maintain a healthy credit score, then debt settlement is not for you. 

How Debt Settlement Works 

With debt settlement, creditors agree to take a settlement that's less than the amount you owe. In return for the settlement, they close the account and stop the collections process.

You can negotiate directly with creditors. Alternatively, you can work with a debt settlement company. Here is what happens when you work with one of these companies:

  1. You provide the company with the names of your creditors and the amount you owe. The debt settlement company then gives you an estimate for reducing your debt along with a new, lower monthly consolidated payment. You may also be advised by the settlement company to stop paying your creditors and instead send payments to the debt settlement company.
  2. The debt settlement company puts your monthly payments into an account. (This account may charge a maintenance fee.) Once the account has grown to a certain amount, which can take months and sometimes up to a year, the debt settlement company calls your creditors and begins negotiating a settlement for each debt. The settlement is an amount lower than your full outstanding balance.
  3. If your creditors agree to a settlement amount, the settlement company pays the creditors and takes a fee for the work of negotiating the settlement. This could be a flat fee or a percentage of the debt (usually at least 15%) that was canceled. 


Avoid debt settlement companies that make guarantees about your debt settlement outcomes or try to charge an upfront fee, which is illegal and a sign of a potential scam.

The Dangers of Debt Settlement

Debt settlement has its advantages. You pay the debt settlement company, which, in turn, pays your creditors. In the end, everyone gets paid, and you're able to move on with your life. It's less time-consuming to hire a debt settlement company than to negotiate with creditors on your own, especially if you have several creditors to deal with.

Debt settlement also has its drawbacks. It can be a long process, and no debt settlement company can guarantee results. There is a chance that you will not see all of your debts settled under one of these programs. Borrowers who pursue debt settlement often have trouble keeping up with payments to their settlement account, dropping out before their debts can be settled.

Creditors won't typically settle debts unless they're a few months past due. That means you have to stop paying your accounts and allow them to become past due if they're not already.


It typically takes 26 to 48 months for the debt settlement company and the credit card company to come to terms. During that time, interest and late fees will make the total grow. Your late payments get reported to the credit bureaus, and your credit score drops.

Regardless of the debt settlement action, those late payments remain on your credit history for up to seven years. Your payment history makes up 35% of your score, so having multiple late payments has a serious impact. Until your score improves, you'll have some difficulty getting credit cards and loans with desirable terms, which means that you'll pay significantly more in interest, and you might not be approved for some loans. For example, you might have challenges getting approved for a home loan.

The Fallout 

If the debt settlement company successfully settles with your creditors, the delinquent information isn't erased from your credit report. Instead, your account is updated to something that shows you've settled, such as "Charged-off settled" or "Paid charge-off."

A settled status isn't nearly as good for your credit score as a "Paid in full" account (though it’s still viewed more favorably than delinquent or past-due accounts that remain outstanding). After debt settlement, it may take a few months or even a few years to rebuild your credit and get approved for unsecured credit.


The Internal Revenue Service (IRS) treats forgiven debts as income, and you may have to pay income taxes on the forgiven amount. Consult a tax professional for advice specific to your situation.

Creditors are required to send you a Form 1099-C for reporting canceled debts, and the IRS will expect you to include the debt on your tax return. You will include that information on your Form 1040.

Alternative Solutions

As of the first quarter of 2021, Americans were in debt to the tune of $14.64 trillion. And 3.1% of outstanding debt was in some stage of delinquency; of the $448 billion of debt that is delinquent, $343 billion is seriously delinquent, at least 90 days late.

Debt is clearly overwhelming for many. If a debt settlement company doesn't sound right for you, here are a few alternatives:

  • Setting up a payment plan with your creditors: If you've missed one or two payments, ask your creditors whether they have a hardship program for customers having financial difficulty. Specifically, use the word "hardship" in your conversation; you may be able to get help in the form of a temporary (six months to a year) reduction in your monthly payment or credit card interest rate.
  • Settling on your own: This approach requires organization and persistence, but you can settle with companies directly. Do all of the negotiations in writing so you have a clear record of what happened, and check your credit report to confirm that your account was settled.
  • Filing for bankruptcy: If you don't have the resources to pay your debt, it may be time to consider bankruptcy. Chapter 13 bankruptcy sets up a repayment plan, and Chapter 7 liquidates your assets to pay your creditors. If you're considering this option, consult a bankruptcy attorney.
  • Consumer credit counseling: With this option, credit counselors review your debt, credit, and financial situation to develop a custom plan for you to move forward, which may include entering into a debt management plan with your creditors. There's a possibility of reducing your monthly payments, and you'll still be able to pay your balance in full, which will reflect on your credit report. As long as you make your payments on time each month, this process will not directly hurt your credit score and can provide you with new information and resources.

If you're considering credit counseling, review our list to find the best credit counseling services.

Frequently Asked Questions (FAQs)

Is it bad to take a settlement on debt?

It's not bad to settle debt. Creditors see it as a negative, however, but it's not as negative as not paying your account at all. Keep in mind that the settled debt will stay on your credit report for up to seven years from when it initially went delinquent.

How much does debt settlement affect your credit score?

How debt settlement affects your credit score depends on several factors. It depends on how much debt you had, how delinquent your debt was, and the state of other debt you have. It also varies depending on how your creditor reports your debt settlement. According to the Center for Responsible Lending, scores may fall by 60 to 100 points, but the exact amount depends on your situation.

Does debt settlement really work?

Debt settlement can work. It depends on several factors, however. Your creditor must be willing to settle. You must be able to pay the amount the creditor is willing to settle for. If your creditor won't settle, or if you and your creditor can't agree, debt settlement won't work in that instance.

What is a good debt settlement percentage?

Debts tend to settle at about 48% of the current outstanding balance, according to the Center for Responsible Lending. That includes interest and fees from the creditor. You will also have fees from the debt settlement company. Your settlements may be higher or lower, depending on your situation and your creditor.

Is debt settlement worth it?

If you have good credit and haven't fallen significantly behind, debt settlement likely isn't worthwhile. If you're falling behind, credit counseling offers many of the benefits of debt settlement without the hefty fees. Ultimately, whether debt settlement is worthwhile depends on the debt settlement company and your creditors, but many consumers benefit from pursuing alternatives.

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The Balance uses only high-quality sources, including peer-reviewed studies, to support the facts within our articles. Read our editorial process to learn more about how we fact-check and keep our content accurate, reliable, and trustworthy.
  1. Consumer Financial Protection Bureau. "Recent Trends in Debt Settlement and Credit Counseling," Page 2.

  2. Federal Trade Commission. "Settling Credit Card Debt."

  3. Federal Trade Commission. "Debt Relief and Credit Repair Scams."

  4. Experian. "What Is Debt Settlement?"

  5. myFICO. "What Is Payment History?"

  6. Internal Revenue Service. "Topic No. 431 Canceled Debt – Is It Taxable or Not?"

  7. New York Federal Reserve. "Quarterly Report on Household Debt and Credit 2021: Q1," Page 2.

  8. Experian. "Will Settling a Debt Affect My Credit Score?"

  9. Center for Responsible Lending. "State of Lending: Debt Settlement," Page 5.

  10. Center for Responsible Lending. "State of Lending: Debt Settlement," Page 8.

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