How Debt Settlement Works

See how debt settlement works and how to use it… or not use it.


Being smart about money is one of the most needed skills.

However, as much as we want to pay all our bills on time, sometimes, it’s not possible. Sometimes, we run into some debt.

And that’s when learning how debt settlement works comes in handy.

It’s an unconventional option, but it has been used with some degree of success by consumers over last few years. This article helps you decide whether you should go with this method for paying off debt.

How Debt Settlement Works

How debt settlement works by having a third-party company service negotiate with your creditors or debt collectors to bring your overall debt total down to a level that’s more affordable for you to pay back.

Since you cannot pay your full debt, they can lower it to a certain price on your behalf.

Until an agreement is reached, it’s usual for debt relief companies to ask you to stop paying your creditor. Instead, they will ask you to open an account wherein you can make regular deposits.

If the creditor or debt collector agrees, then you can use the amount saved on your account to pay for the lump sum amount negotiated.

Then, you have to continue depositing on the account until you reach the amount negotiated.

You should also pay the debt settlement company for their services.

They usually require a percentage of the amount you saved with their negotiation. But this differs for every debt relief company.

However, there is a chance that the creditor or debt collector will not agree to any negotiation.

Risks of Debt Settlement

There are several risks that you should know before entering an agreement. Settling debt is usually a last resort method for people deep in debt. 

If there are other methods available, then you should try to avoid debt settlement.

However, if there is nothing else you can do, then you have to face a few risks in debt settlement.

Affects your credit

One of the biggest impacts of debt settlement is on your credit score. If you stop making payments, your credit score can take a huge toll if you are not paying your debt obligations. It will reflect on your credit reports for seven years.

The creditor may not accept negotiations.

This is the worst-case scenario. If your creditor did not accept any payments, then your credit will be worse than before. Your creditor may sue you over the debt. They might continue and even be more aggressive with their collection.

Fees, penalties, and interest will continue to accrue.

There is no guarantee that a negotiation will be reached. Negotiation may not be reached even if you are depositing on the account. If this happens, you have to pay for all the fees accumulated during the negotiation. This will also show up on your credit report and affect your credit score.

More taxes.

If you do not do enough research, you may find yourself in a worse situation than before.

The debt that you were forgiven through the negotiations can be considered as a taxable income, and therefore, you have to pay for it on your federal income tax.

Fees to the debt relief company.

If the debt settlement company is successful in settling your debt, it doesn’t mean that the fees are over.

You still have to pay the debt relief company fees that include your monthly deposit towards the lump sum, setup fee, and monthly fee for the account.

Companies may scam you.

There are a lot of fraudulent companies that take advantage of people in need. They may be able to successfully negotiate with your creditor but you may face more fees than before.

You should extensively research the companies you will talk to.

It’s helpful to try and look for reviews or other testimonials across the web.

Alternatives to Debt Settlement

Here are other ways to accomplish your goals…

Negotiate on your own

You can try to negotiate without approaching any debt relief company. It’s better if you have a big lump sum you can pay for immediately and then follow up later on, based on your negotiations.

Seek nonprofit organizations

There are several nonprofit organizations that provide credit counseling services. They can help to talk to creditors on your behalf to stop collection efforts or avoid a lawsuit.

0% Interest Credit Cards

If you still have good credit, you can apply for credit cards that offer 0% interest so that you can withdraw money to either pay the lump sum negotiated or at least avoid fees from piling up.


If there is nothing else you can do, and debt settlement works within your acceptable risk management levels, then it might work for you.

But always remember, there are more risks with this solution than there are with other debt elimination programs.

So you should take this decision very seriously.

If you decide to go with this option, the key to success comes down to picking the right that settlement firm to do the work on your behalf.

Choose the wrong one and you could be headed for the worst financial crisis of your life. Leaving you in a worst position than when you started.

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