Debt Settlement Pros and Cons

Debt Settlement Pros and Cons
BY Gideon Sandford
Apr 30, 2023
Key Takeaways:
  • Debt settlement is a way to pay your creditors less than you owe while avoiding bankruptcy.
  • Your credit score may drop while you pursue debt settlement.
  • If you successfully settle your debts, you may owe taxes on any amount that’s forgiven.

It's no secret that getting out of debt can be a lot harder than getting into it. If you're feeling overwhelmed by debt, there are a range of options available to help you get your debt under control. Debt settlement is one way you may be able to pay less than you currently owe without going through bankruptcy. There are also risks to entering a debt settlement plan, so make sure you understand the advantages and disadvantages of debt settlement.

Here's a closer look at how these plans work.

What is debt settlement and how does it work?

Debt settlement means convincing your unsecured creditors to accept less than your total balance as payment in full. Here are the basics:

  • The first step is saving up a lump sum to offer one or more of your creditors. You may be able to borrow it from friends and family, use your existing savings, sell some assets, or build up a balance over time in a debt settlement savings account instead of paying your unsecured creditors.

  • Once you have enough money saved up, you or your debt consultant contacts your creditors and offers them a percentage of the total due as payment in full. Often, that contact takes the form of a debt settlement letter.

  • If you and your creditors reach an agreement, you or your debt consultant will draw up a written agreement and send it to the creditor to sign.

  • After you have a signed agreement, you send the amount you agreed on to the creditor. It's helpful to include a conditional endorsement referencing the written agreement when you make the payment.

Once you've settled with a creditor, be sure to check your credit report to make sure the balance is zero. 

Debt settlement pros

Debt settlement has a few advantages over other approaches to resolving your debts.

Privacy protection

Unlike bankruptcy, debt settlement takes place outside the court system. Bankruptcy, meanwhile, creates a public record that anyone can find. That includes future employers, professional licensing agencies, romantic partners, or even in-laws. If bankruptcy would embarrass you or harm you professionally, debt settlement might be a better option.

Less damage to credit scores

Filing for bankruptcy can do a lot of damage to your credit score. Chapter 13 reorganization bankruptcies appear on your credit report for 7 years and Chapter 7 liquidation bankruptcies appear for 10. Having a bankruptcy on your credit report may disqualify you from renting a home from some landlords, and some jobs. 

Debt settlement also hurts your credit score, but people's scores tend to recover more quickly and more fully after debt settlement versus bankruptcy.

Higher success rate

Only about one in three Chapter 13 bankruptcies are completed successfully. In contrast, about 60% of consumers in debt settlement successfully complete their program if they stick with it for at least two years. 

If you qualify for Chapter 7 bankruptcy, which is difficult, you've got an even greater chance of success (more than 95%). 


A debt settlement plan may be more affordable than a debt management program or Chapter 13 bankruptcy. Chapter 13 enrollees often pay more than the original amount of their debts because of attorney fees and court fees. Debt management programs are not designed to reduce the balance that you owe. 


Debt settlement may also help by giving you a sense of control over your debt. Confronting your debt and taking positive action by negotiating a debt settlement or saving up money to make a settlement offer in the future can help put you back in control of your finances.

Debt settlement cons

Debt settlement may allow you to pay creditors less than you owe, but it comes with risks and other downsides you need to be aware of.


If you stop paying your creditors, they may start aggressively pursuing you with phone calls and threatening letters. They may send you texts or emails as well. They can also send your account to a collections agency or sue you to get a court to order you to pay.

You don't have to stop paying your bills to do a debt settlement program but you might choose to. That's because creditors are more likely to negotiate if they think you can't pay the full amount.

No guarantee

A debt settlement plan isn't guaranteed to reduce the amount you owe, and a reputable debt settlement company will never promise that it can settle your accounts, reduce the amount you owe, or make any other claims like that.

Debt settlements are voluntary, and no creditor is required to settle with you no matter how much you can offer. If a creditor refuses to settle, you may damage your credit score by refusing to pay and still end up owing the same amount or more after the creditor applies fees and penalties.

If your creditor believes that you can afford to repay your entire balance, they may refuse to negotiate a settlement.

If you file for bankruptcy, your creditors can't opt out. Plus, they can't continue collection efforts.


Professional debt settlement companies typically charge a fee of between 15% and 25% of the debt you're trying to settle. They may also charge a commission based on the amount of your debt that's successfully settled. 


The tax treatment of settled debt is complicated, and you should contact a tax professional if you have questions about your specific situation. The amount of debt forgiven in a debt settlement may be treated as taxable income. However, if you qualify as insolvent (your liabilities are greater than your assets), then the amount of your debt that's forgiven may not be taxable.

How to decide if debt settlement is right for you

Decide how to tackle unaffordable debt by asking yourself these questions first:

  • How much disposable income do I have? Low-income debtors might do better in bankruptcy.

  • Am I insolvent? If your liabilities are greater than your assets, forgiven debts won't be taxed and debt settlement may be a good path forward.

  • How much debt am I trying to get rid of? For very large amounts, bankruptcy might be less expensive because bankruptcy lawyers tend to charge flat fees. 

  • How likely are my creditors to settle? If the debt is old, has been charged off or sold to a debt collector, debt settlement becomes easier. 

  • Can I document a financial hardship? Your creditors are more likely to negotiate if your financial position is obviously weak.

  • Will a bankruptcy make me ineligible for work or embarrass me? Bankruptcies are public record, but debt settlement is not.

  • Can I afford to keep up with a debt management plan? If so, you'll do less damage to your credit compared to other options.

It's important to weigh debt settlement pros and cons before attempting to resolve your payment problems. Understanding the pros and cons of debt settlement and other options can help you choose the most effective solution for your situation.

Frequently Asked Questions

What’s worse for credit scores, debt settlement or bankruptcy?

Debt settlement and bankruptcy will both appear as negative marks on your credit report and will almost certainly lower your credit score. Debt settlement may have less of an impact than bankruptcy on your credit scores over time.

How much debt settlement lowers your score depends on your starting score. If you’re already missing payments, then debt settlement may not hurt you much. If you have a perfect history of on-time payments, then stopping payments or settling your debts may cause your credit score to drop fast. Once your debts have been settled, your score should increase over time if you pay on time, keep your credit card balances low, and avoid applying for credit until you need it.

Is debt settlement better than debt management?

The right solution for you depends on your situation. Debt management has a lower success rate than debt settlement, but that’s because many people can’t afford the monthly payment. If you can safely afford to make your debt management plan payment, it’s a good solution because it costs very little and doesn’t hurt your credit much. But if you can’t afford your debt, debt settlement may be a better way to go. The Federal Trade Commission (FTC) says that debt settlement is more affordable than debt management. 

How much debt can be forgiven with debt settlement?

The amount of debt forgiveness that you can achieve through debt settlement depends on what your creditors are willing to accept. There is no guarantee of what they will forgive. In general, older debts that have already been written off or sold to debt collectors are easier to negotiate than new debt. And if you can prove financial hardship and insolvency, creditors tend to be more forgiving.