Credit Counseling vs. Debt Settlement

Serious debt may require some outside help

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For people who are struggling with debt, credit counseling organizations and debt settlement firms are two types of entities that can offer help, but they are very different. 

Credit counseling agencies are often nonprofit organizations that can offer you a range of services, including setting up debt management plans with creditors. But don’t confuse them with debt settlement firms. 

Debt settlement firms are for-profit and negotiate with creditors on your behalf to reduce the principal balance owed. However, they can lead to serious credit and tax implications.

When deciding between credit counseling or debt settlement, it’s important to understand how each one works. Read on for a breakdown of what each type of organization can do for you, what it will cost, how it affects your credit, and how long it may take to get out of debt.

Key Takeaways

  • Credit counseling firms are often nonprofit organizations that will create a debt management plan to help you pay your debt.
  • Debt relief or debt settlement companies are for-profit organizations that will seek to negotiate a reduction in the amount you owe.
  • Whichever you choose, evaluate the firm carefully. Make sure you understand the services offered, the fees, and other costs, such as a reduced credit score or an unexpected tax bill.

What Is Credit Counseling?

Nonprofit credit counseling organizations are designed to help counsel people who have financial hardships. Usually, you can get a free consultation and help with a budgeting plan. Credit counselors can also explain the various options available to people with a more serious debt problem that they can’t manage on their own. If you’re in that situation, a credit counselor can create a debt management plan for you.

What Is a Debt Management Plan?

If you are carrying a lot of unsecured debt (like credit card debt), a credit counseling agency can work with you to develop a debt management plan (DMP). First, they’ll figure out how much you can afford to pay toward your debt per month and put you on a budget. Then, leveraging the relationships they have with creditors, the firm will work out a deal with them. Sometimes that deal includes reducing your interest, reducing your monthly payment obligations, and/or spreading out your payments over time.


With a debt management plan, the amount of your debt will not be reduced, and you will repay the entire amount you owe.

Once a plan is arranged, you will pay the credit counseling agency a fixed amount each month. They will use that money to make payments to your creditors for the agreed-upon length of time until your debts are paid. In other words, you’ll go from making several payments to one payment per month. You will usually pay a fee to the credit counseling agency, which is tacked on to that one monthly payment. As part of the DMP, you will likely have to agree to stop using your credit card accounts, so you will not have access to credit during the payoff period.

What Is Debt Settlement?

Debt settlement refers to negotiating with creditors and lenders to pay less than what you owe. This can be done on your own, or through a third party known as a debt settlement company or a debt relief firm. For some consumers, debt settlement could be an alternative to declaring bankruptcy.

What Are Debt Settlement Companies?

Debt settlement companies are usually for-profit organizations whose main goal is to help you reduce the amount of debt you owe so you can settle your accounts. They charge fees, although they aren’t allowed to do so upfront, as per the Federal Trade Commission’s Telemarketing Sales Rule. Typically, the company will recommend that you stop making payments to your creditors, and instead, funnel that money into a savings account. This money will eventually be used to make lump-sum payments to settle accounts with your creditors.


Unfortunately, some debt settlement companies may not have your best interests at heart. Be diligent and choose a reputable company if you decide to go this route.

Although it sounds promising to pay less than what you owe, you should be aware of the downsides to debt settlement. First, creditors are not obligated to agree to a debt settlement, and some may flat-out refuse to work with certain debt relief companies. There are no guarantees that creditors will be willing to reduce your balance. Second, during the time that you stop making payments, late fees will be tacked on, interest rates may increase, and your credit score will plummet. You may also begin to receive debt collection calls, or even threats of legal action, from your creditors.

If the debt settlement company negotiates successfully, you are responsible to pay taxes on the amount of debt that was forgiven. That’s because the IRS considers forgiven debt to be income. Plus, whatever fees that the debt settlement company charges will be assessed, as well. Therefore, unless the settlements reduce your balances in a significant way, the savings may not end up being as much as you’d think.

Credit Counseling vs. Debt Settlement

For most consumers, credit counseling and a debt management plan will usually be the more favorable path over debt settlement. Here’s how it breaks down:

  Credit Counseling  Debt Settlement
Fees You may be charged a modest setup fee (around $30-$50), and then a monthly fee (ranging from about $20 to $75 on average) for the duration of the DMP.  Expect fees to be around 15% to 25% of the amount settled. 
Credit Score Impact As part of a DMP agreement, creditors may agree to keep your account status as “current.” As your balances go down, your credit score may start to improve. Your credit score will drop significantly once you stop making payments. When you settle your debts, your accounts will be marked accordingly, which may be looked upon negatively by future lenders. 
Types of Debt That Are Eligible  Unsecured debt like credit cards, personal loans, or medical bills Usually unsecured credit card debt, though some companies offer assistance with personal loans, medical bills, etc. 
Impact on Debt Your principal is not reduced, but creditors may waive fees and/or lower the interest rate on the accounts.  Your principal amount is reduced, but you have to pay it all in a lump sum. 
How Long It Takes 3-5 years 3-4 years 
Tax Implications  No impact since you’re not reducing your debt. Reduced debt is considered taxable income. So if you owe $20,000 and your creditor reduces the bill to $12,000, you’ll have to pay income taxes on $8,000.

How to Find a Reputable Firm

Make sure that the credit counseling agency you chose is a member of the National Foundation for Credit Counseling or the Financial Counseling Association of America. This will tell you that the agency follows strict standards and is accredited. This will also tell you that individual counselors are certified and kept accountable. 

You can also do some additional sleuthing online at the Better Business Bureau or other consumer watchdog or review sites. Consider asking for a referral from someone you trust.


When you connect with a prospective counselor, make sure you feel comfortable working with them. Ask lots of questions and look for transparency about the services they offer.

If you decide that debt relief is the route you wish to take, you’ll have to be a bit more thorough in your research.

Though some debt relief firms are reputable, others look to take advantage of people who feel desperate. Spend time vetting potential debt settlement firms. When you do reach out, a firm should be able to provide a breakdown of what they charge, how long the process will take, and how much you can potentially save. If they try to charge you money upfront or make guarantees about how much they can reduce your debt, consider those to be red flags and walk away. You should also confirm, should you decide not to move forward, that you’ll have access to your money and will be able to withdraw it at any time without penalty.

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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. National Foundation for Credit Counseling. "How Counseling Works."

  2. Consumer Financial Protection Bureau. "What's the Difference Between a Credit Counselor and a Debt Settlement or Debt Relief Company?"

  3. FTC. "Coping With Debt."

  4. FTC. "Telemarketing Sales Rule."

  5. Consumer Financial Protection Bureau. "What Are Debt Settlement/Debt Relief Services and Should I Use Them?"

  6. IRS. "Canceled Debt – Is It Taxable or Not?"

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