Debt Relief Programs: How They Work and What to Look For

cropped-FDR article HowDoes-min
BY Gina Freeman (Pogol)
Mar 30, 2022
 - Updated 
Dec 19, 2023
Key Takeaways:
  • Debt relief could help you get rid of debt that you can’t afford to repay.
  • Debt relief means negotiating settlements with creditors and asking them to accept less than the total owed as payment in full.
  • Creditors are not obligated to settle debt and results cannot be guaranteed.

Debt relief programs are designed to help consumers struggling with more debt than they can afford. In its simplest form, a debt relief program means that your creditors agree to accept less than what you owe as payment in full. 

How Does a Debt Relief Program Work?

Debt relief typically works this way: you enroll your unsecured accounts into a debt relief program with a debt settlement company. You typically choose to stop making payments to your creditors. You and your debt consultant come up with an amount that you can afford, and you put that money into a debt settlement savings account each month. Debt relief programs could help you get rid of debt faster than making minimum payments.

Negotiations begin with creditors when you have saved enough. You continue to make your monthly payments into your dedicated account as your debts are settled one by one. You pay no fees to a debt settlement company until it settles a debt for you, you authorize that settlement, and the first payment has been made.

You could speed up the settlement process by cutting expenses or selling things you don’t need to reach your savings goal faster. 

Why would creditors agree to settle my debt?

“Why would my creditors agree to settle my debt?” you might well ask. Creditors are not in business to lose money. They only agree to a debt relief program if they believe that other options will cost them more and that you can’t afford to pay what you owe. Creditors are less likely to settle if you’ve made your payments and have a good credit score. They assume that you’d like to protect that score and that you can afford to do so. 

However, if you start missing payments, it becomes obvious that you’re having trouble paying what you owe. Creditors begin to fear that you might even walk away or file bankruptcy and pay nothing (or practically nothing). If a debt is older, your state’s statute of limitations for debt could kick in and make your balance uncollectible. Once a creditor concludes that something is better than nothing, you have a good chance of settling your account.

How long does a debt relief program take?

Debt relief generally takes between two and four years, depending on the amount of enrolled debt, how fast you can save for debt settlement, and how much your creditors are willing to accept. A debt consultant could help you estimate your timeframe. In many cases, the first account can be settled in four to six months. Over time, debt relief programs could help you get rid of debt that you can’t afford.

What kinds of debt can I settle with a debt relief program?

Debt relief is not for loans secured by collateral, like mortgages or auto financing. If you stop paying secured creditors, they can foreclose on your home or repossess your car. However, a debt relief program can work with unsecured creditors. Here are the most common types of unsecured loans that you might be able to settle with debt relief:

  • Credit card debt

  • Unsecured personal loans

  • Medical bills

  • Private (not government-guaranteed) student loans

  • Peer-to-peer (P2P) loans

When attempting debt settlement, you could be dealing with the original creditor, a debt buyer, or a collection agency.

What’s the difference between an original creditor, a debt buyer, and a collection agency?

Original creditors are the people or companies you borrow from – like banks that make personal loans or credit card issuers. Protections guaranteed by the Fair Debt Collection Practices Act (FDCPA) do not apply to original creditors.

So, while debt collectors have to leave you alone once you ask them to stop contacting you, original creditors may be able to keep calling. Your state may or may not have laws in place to protect you from aggressive collection efforts from your creditors.

Collection agencies make money by collecting debt for others. Original creditors may turn accounts over to collections and pay the agency a fee for collecting, or they might sell the debt at a discount to the agency. Debt collectors are covered by the FDCPA and must stop contacting you if you ask them to. 

Debt buyers purchase the right to collect a debt from original creditors or collection agencies. Debt buyers own the debt and have the same legal rights as original creditors unless their main business is debt collection. In that case, they fall under the FDCPA, just like collection agencies. 

Why does it matter who owns your debt? It can impact the amount of contact you get when you’re in a debt relief program. It may also determine how willing the debt holder is to settle and how much it might accept. A debt buyer that paid pennies on the dollar for your old account may be willing to settle readily for a modest amount. While your credit card company will probably pursue you for the entire balance, especially if you recently charged expensive purchases.

Is a debt relief program a good idea?

Debt relief programs aren’t for everyone. They are a solution for serious debt problems, not a get-out-of-jail-free card for people who just don’t want to pay what they owe. Consider both the pros and cons of debt relief before committing to a program.

A debt relief program may help you get rid of debt if you can’t afford the minimum payments on your debt or if your debt is creating hardship for your family. It could be a better solution than bankruptcy if you don’t want a public filing, if you have a previous bankruptcy, or if you don’t want a bankruptcy court taking total control of your finances. 

How does a debt relief program affect my credit?

Most debt relief programs ask that you voluntarily stop making payments to your creditors and instead pay into a dedicated account. Every missed payment will lower your credit score. 

If you currently have a high credit score, this can be devastating. Those who have more to lose will lose more. But if you’re having trouble paying your bills and already missing payments, the damage is less obvious. 

What happens to your credit score after you graduate from a debt relief program?

Your life should be more affordable after getting rid of debt. With a bit of luck and sound financial management, you should be able to pay your bills on time and continue to improve your credit profile.

Can I negotiate with creditors myself?

There is no reason that you cannot attempt debt settlement yourself. Here are the steps you’d take:

  • List the amounts you owe to each creditor and the minimum monthly payment. If collection agencies are after you, they’re probably demanding the entire balance owed.

  • Go through your budget – your after-tax monthly income and every necessary cost you have. Plan to get rid of expenses you don’t need to live when you start your debt settlement plan. 

  • Subtract your total required expenses from your after-tax monthly income. That’s how much you can afford to use for debt settlement. 

  • See how much money you can offer your creditors to settle your debts. Consider selling things you don’t need, borrowing against your 401(k) at work, or tapping your savings. That can start your debt settlement fund.

  • Now comes the hard part. Stop paying your creditors. This is usually necessary because few creditors will settle an account when you make payments. Instead, put those amounts into your debt settlement fund.

  • Expect phone calls, letters, voicemails, collection calls at work, calls to your cell phone, even texts and contact through social media. You might be able to limit some of this contact by sending cease-and-desist letters.

  • Once you’ve saved enough to offer a creditor, contact it and negotiate an amount to clear your balance. Supply proof of your financial hardship to convince your creditor that you cannot afford to pay more. Do not send money until you have a signed, written agreement. 

  • Work through your creditors one by one until you clear your balances.

Understand that your creditors are not obligated to settle with you and may even take you to court. If you lose, you’ll owe your balance and probably collection fees and court costs, and your creditor may be able to garnish your paycheck.

How much could I save with a debt relief program?

Your creditors are under no obligation to settle with you. No reputable debt relief company will guarantee that it can wipe out your debts or clear your balances for “pennies on the dollar.” Your experience will likely depend on the age of the debt, the type of creditor, and how well you present evidence of financial hardship. 

If you can show that you’re insolvent and a good candidate for bankruptcy, you’re more likely to succeed at debt settlement than if you earn a high income, spend on luxuries, and can’t prove hardship.

Statistics can help you visualize the potential for savings through debt settlement, but specific results cannot be guaranteed or predicted. A recent study by Will S. Dobbie at the Harvard Kennedy School entitled “Financial Outcomes for Debt Settlement Programs: Estimates for 2011-2020” found that, on average, consumers settled balances of $17,032 for $8,365, paying fees of $3,325. That’s a reduction of 51% before fees and 31% savings after fees. 

Debt Relief Pros and Cons

Debt relief programs may be able to help you get rid of unaffordable debt. However, such solutions always come at a cost. If you can afford to repay your debt in a reasonable timeframe, consider doing so.

Debt relief pros

  • Get rid of unsecured debt faster.

  • Pay less than the full amount that you owe.

  • Control how much you offer.

  • Keep your debt problems private by avoiding bankruptcy.

  • There is less damage to credit score than bankruptcy, according to Experian.

Debt relief cons

  • Creditors may call aggressively while you aren’t making payments.

  • Creditors may file lawsuits.

  • Success is not guaranteed.

  • Credit score will suffer when you start missing payments.

  • Forgiven amounts may be taxed by the IRS.

It’s wise to consult with a tax professional before choosing debt relief to determine if you meet the guidelines for insolvency.

What’s it Like to Go Through Debt Relief?

Your experience with a debt relief program is highly individual. It depends on how quickly you can come up with a lump sum to settle your debts, the age of the debt, who your creditors are, how aggressive your creditors are, the size of your debt, and the amount of your income. 

Here is a typical debt relief experience with a debt relief company. First, the company must inform you thoroughly about its program, including:

  • Debt relief fees and any conditions relating to its debt relief services

  • How many months or years before it will make a settlement offer to each creditor

  • How much money or the percentage of each balance you must save before it will make a settlement offer

  • What could happen while you’re not making payments to your creditors – including damage to your credit score, possible lawsuits from creditors, and interest and penalties added to your balance

The debt relief company also must tell you that:

  • The money you deposit with your plan is yours, and you are entitled to any interest earned.

  • The account administrator is not affiliated with the debt relief provider and doesn’t get referral fees.

  • You may withdraw your money at any time without penalty.

You will work with your debt counselor to decide what debts to enroll in the plan and develop an affordable monthly plan payment. You’ll also look at other ways to increase what you can offer your creditors, whether it’s a loan, tapping your savings, or selling some assets. You will probably be advised to stop making monthly payments on your enrolled accounts.

Your debt consultant may advise you about calls from creditors and debt collectors. Federal law gives you total control over how much contact you get from creditors, but credit card companies will probably continue to contact you. You may also choose to communicate with your creditors during this time.

According to data from Freedom Debt Relief, your credit score is likely to drop substantially during the first few months of your debt relief program. But after that first six months, credit scores trend higher. 

Debt Relief Scam: Red Flags 

Debt relief is a financial service with lots of government oversight. The Federal Trade Commission (FTC) warns consumers about these red flags when doing business with a debt relief company:

  • Asking for upfront fees before settling any debts – by law, debt relief companies cannot take a fee until they have negotiated a settlement and you have agreed to it

  • Claiming to “wipe out” your debt for “pennies on the dollar”

  • Guaranteeing that they can settle your debt for any specific percentage

  • Touting a "new government program" to bail out personal credit card debt

  • Telling you to stop communicating with your creditors

  • Claiming it can stop all debt collection calls and lawsuits

Debt relief may be able to solve your debt problems, but it’s not all rainbows and puppies. Avoid companies that try to present an unrealistic picture or collect fees they have not earned.

What Happens After Graduating From a Debt Relief Program?

When your last enrolled debt is resolved, you graduate from debt relief. You are free to move on, stay on track, and avoid taking on too much debt in the future. 

You may owe taxes on forgiven debt forgiven under a debt relief program. The IRS says forgiven debt is taxable for the year settled unless you are financially insolvent. That’s why it’s crucial to determine if you qualify as insolvent or if you need to budget for those taxes.

Your credit report is likely to show missed payments, and creditors can note that your account was “settled for less than the amount due.” These entries can remain for up to seven years and may raise questions when you apply for a mortgage or auto financing.

However, credit scores update continuously, and recent history gets more weight than older entries. Keep paying your accounts on time, avoid carrying balances on your credit cards, and eventually, you could achieve financial stability and excellent credit.

>>Learn more: Watch Freedom Debt Relief reviews

Frequently Asked Questions

How much taxes would I owe for forgiven debt?

For many consumers, debt forgiven in a debt relief program is considered income. If your debt relief is taxable, your taxes will depend on the tax bracket that your income places you in. Here are tax brackets for the 2021 tax year if you’re married and filing jointly:

Income rangeTax
0 - 1975010% of the amount over $0
19750 - 80250$1,975 plus 12% of the amount over $19,750
80250 - 171050$9,235 plus 22% of the amount over $80,250
171050 - 326600$29,211 plus 24% of the amount over $171,050
326600 - 414700$66,543 plus 32% of the amount over $326,600
414700 - 622050$94,735 plus 35% of the amount over $414,700
622050 - no limit$167,308 plus 37 % of the amount over $622,050

If you’re a married couple and your creditors forgive $10,000 of debt, your tax would range from $1,000 to $3,700. 

Does enrolling in a debt relief program stop collection calls?

You can stop calls from debt collectors by asking them to and by following up with a written cease-and-desist letter. If a debt collector continues to call, it’s a violation of the Fair Debt Collection Practices Act (FDCPA) and you could sue the collection agency for damages. 

However, the FDCPA doesn’t apply to primary creditors like your bank, personal loan provider, or credit card issuer. In many states, they can continue to call you whether you like it or not. And when you stop making payments to save for a debt settlement offer, your primary creditors will probably call you. 

That said, once you or your debt settlement company reaches a settlement with your creditor, there is no reason for collection calls. 

Do creditors settle with consumers who try DIY debt settlement?

Some do and some don’t. Every creditor has its own policy. Some do not settle debt, period. Others have relationships with debt settlement providers and are accustomed to working with them. The bottom line is that DIY debt settlement is possible and there is no reason not to attempt it. You can always hire a debt settlement company if you want professional assistance.