What is Debt Settlement? How is it Different from Credit Counseling?

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If it feels as if you’re drowning in debt, you are probably considering your options. You may be getting advertisements in the mail from companies offering to help you negotiate a debt settlement.

But what is debt settlement? How does it work? And how is it different from credit counseling or a debt management plan?

Solvable provides the answers so you can make a more educated decision, get a handle on your debt, and start on the path to financial freedom.

What Is Debt Settlement?

What is Debt Settlement? How is it Different from Credit Counseling?

A debt settlement allows you to pay off your debts at a fraction, or percentage, of what you owe. It’s not uncommon to settle debts at 10 to 60 percent of your balance.

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Debt settlement is sometimes called debt resolution. It’s entirely possible to negotiate a debt settlement yourself, but companies may sometimes help you negotiate a more favorable agreement. Reputable debt settlement firms know the rules, nuances, and ins-and-outs of debt settlement.

How Is Debt Settlement Different from Credit Counseling or a Debt Management Plan?

Debt settlement isn’t your only option if you have unmanageable debt. You might consider credit counseling.

A credit counselor will work with you to create a budget and better manage your finances so you can get a handle on debt. As part of this, a credit counselor may help you set up a debt management plan (DMP). Solvable talks more about the benefits of a DMP in this article.

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How Much Credit Card Debt Do You Owe?

A debt management plan may allow you to eliminate fees and late charges, and reduce interest on your debt. It may even reduce what you owe, but you will still have to make payments to pay the remaining balances. This is an important difference between a debt settlement and a debt management plan. When your creditor agrees to a debt settlement, you make one payment and it’s done. You don’t have to worry about that bill ever again, so you can start rebuilding your credit immediately.

Additionally, a debt management plan requires that you include all your unsecured debt—even bills you’ve been paying on time. When you negotiate debt settlements, you can “cherry-pick” which debts you’d like to settle and which you’d like to continue paying on time each month.

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You can get credit counseling and set up a debt management plan without any late payments on your credit report. In fact, you might be in a stronger position if you haven’t yet missed a payment on your bills.

How Is Debt Consolidation Different from Debt Settlement?

Debt consolidation may be part of a DMP. Debt consolidation occurs when you pay a single monthly payment to a debt consolidation agency, which distributes the money to each of your creditors. For many people, debt consolidation offers an easy way to work toward paying down your balances with one monthly payment that fits your budget.

What Types of Debts Can You Settle?

Most consumers who consider debt settlement look specifically at reducing their revolving credit card balances. Student loans and loans backed by the government are not typically eligible for debt settlement.

Besides credit cards, other loan balances you may be able to settle include:

  • Auto loans after a car has been repossessed
  • Personal loans
  • Medical bills
  • Utility bills and cell phone bills
  • Apartment leases following an eviction

How Debt Settlement Works

If you’ve missed several payments on your credit cards or other unsecured loans, you could be in a position to settle or resolve those debts. If you have debts you can’t pay, you can call your creditor and negotiate a “settlement.”

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Before you propose a settlement or make an offer, be certain you have the money available to pay whatever you settle on. This might involve establishing a savings account and making payments into it for several months—or even years.

If you’re negotiating on your own, make an offer that is a few hundred (or thousand!) dollars lower than what you can actually afford. Your creditor may try to negotiate for more. Or, they might accept your offer and then you’ve saved money you can put toward other debts!

Once your creditor receives the partial payment, they wipe the debt from their books.

Are You Eligible for Debt Settlement?

If you’ve missed payments on your loans, you may qualify for debt settlement.

Be aware: If you’ve missed more than three payments, your creditor may have sold your debt off to a collections agency. Then you’ll be negotiating with the agency. Otherwise, you’ll negotiate directly with your creditor. You can manage the negotiations yourself, or hire a debt settlement agency to help.

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In either case, the creditor or agency is typically willing to reach an agreement. After all, collecting a portion of the debt is better than receiving no money at all. And settling a debt is also cheaper for them than paying legal fees to try to collect the money.

Facts to Know about Debt Settlement

  • You won’t be able to negotiate a debt settlement until your account is past due. Late payments “send the message to your creditor that you’re either unable or unwilling to pay,” says Lifehacker.com.
  • A debt settlement will be reflected on your credit report as “settled.” You may be able to negotiate to have the debt reported “paid as agreed,” which is more favorable. Either way, debt settlement will hurt your credit score, and it will take time to rebuild it.
  • The “forgiven” debt (the amount you don’t have to pay) could be reported as taxable income. Then you’ll be responsible for paying taxes on that money. If you’re concerned, speak to your accountant before debt settlement to see how this may affect your tax refund or liability.
  • Debt settlement is usually better than bankruptcy, but your mileage may vary.
  • Creditors don’t always accept your settlement offer.

Working with a Debt Settlement Agency

You can definitely negotiate a settlement on your own. But if you are already feeling harassed by creditor calls, frazzled about your financial situation, or depressed about debt, you may want some help.

If you plan to work with an agency, collect a list of all your debts you wish to settle, including the amounts owed, interest rates, fees, and how far past due they are.

Your debt settlement company may charge an upfront fee. First, they will advise you to stop making any payments on the debts you want to settle. Then they will provide an estimate of how much they will be able to settle for. Be aware of any companies that make unrealistic promises or say they can have your debt wiped out. The fact is, these companies don’t know. And the market is rich with scam artists.

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You’ll start making monthly payments to the debt settlement firm, which will go into a third-party escrow account. As your savings grows, the debt settlement firm will begin the process of negotiating.

Be aware that your creditors can still charge interest and late charges while you’re waiting to settle.

Once the debt settlement agency makes an offer the creditor approves, you’ll receive an agreement. Sign and return the agreement, keeping a copy as proof.

Your debt settlement company will make the payments on your behalf. Your creditor will report to the credit agency as agreed upon. With your debts settled, you can begin to rebuild your credit.


Your credit score may begin to show incremental improvements once all your debts have been settled, if you continue to make other payments on time. It could be seven years before you see a “good” credit score again. But the sooner you start the process, the sooner you’ll start to improve your credit.

Choosing Debt Settlement, Credit Counseling, or Debt Consolidation

Whether you choose debt consolidation, credit counseling and a DMP, or debt settlement, the important thing is to take action today. Any of these options are better than bankruptcy, which should always be a last resort.

Understand that there are resources available to help you, whether you decide to work with an expert debt settlement firm or take on the challenge of negotiating with creditors yourself.

Solvable can help you get started right now.

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