How Does Debt Settlement Work?

If you’re in debt, it might seem obvious that the only way to satisfy your creditors is to pay back what you owe in full. But there’s another option: pay back just a portion of what you owe through debt settlement.  

Settling your debts is similar to paying them off, but it involves a few extra steps. And debt settlement can work much faster than paying back your debts in full through minimum payments. If you’ve experienced some sort of financial distress that’s made it difficult for you to pay back your creditors, then a debt settlement program could help. 

So how exactly does debt settlement work? In a nutshell, debt settlement is the process of negotiating with creditors to reduce the amount owed on a debt. Creditors agree to accept a reduced amount to satisfy the debt, and then they forgive the rest. The person who owed the debt is able to pay off the debt for less and faster than making monthly minimum payments. 

How Debt Settlement Works in 11 Steps

Debt settlement is a way to take control of your debt if you’re experiencing financial hardship and falling behind on your bills. By asking your creditors to accept less than you owe on some overdue debts, debt settlement could reduce the total owed and make your payments more manageable. 

Debt settlement is based on a structured process of negotiating with creditors. These negotiations aim to reduce the amount you owe. Once that amount is more manageable you can start working towards a debt-free future. 

Anyone can try to work with creditors to settle their own debts. But the debt settlement process can be exhausting and stressful because creditors often play hardball. If you don’t want to negotiate your own debts, you have the option of working with a professional debt settlement company. If you do, this is generally how the process will go.

Here’s a concise guide to understanding how debt settlement works.

1. Assess your financial situation

Start by listing all your debts, income, and expenses, including current debt payments. This gives you a clear picture of what you owe and how much you can afford to pay. Laying all this out will help you know how close you are from being able to pay your current debts.

If there’s a wide gap between what you owe and what you can afford, debt settlement may be a good option for you. Debt settlement is for people who are experiencing a financial hardship that makes it difficult or impossible to fully repay their debts.

2. Contact a debt settlement company

Once you’ve taken stock of the situation, find a reputable debt settlement company. These companies negotiate with creditors to lower the total amount you owe. Research the background and fees of different companies. Also read reviews from past customers. Choose one that fits your needs. 

3. Enroll in a debt settlement program

After choosing a debt settlement company, enroll in their program. First, read their agreement carefully. Then, request a free consultation about your situation. Once your consultant knows the details, they should provide you with a customized debt resolution plan.

The process is likely to involve setting up a dedicated account where you will deposit money regularly. Your creditors will be paid from this account once settlements are reached. The account is yours and you always control it.

4. Stop making payments to creditors

To build funds for settlements, many people choose to stop making direct payments to creditors. It could be difficult to save money for settlement offers otherwise. Instead, you’ll make one monthly payment into the dedicated account set up by the debt settlement company. This step could lead to collection calls and a drop in your credit score. Your debt settlement consultant should be able to advise you. 

5. Make monthly deposits into a settlement account

Each month, you’ll deposit a set amount into the settlement account. Making regular deposits is key. They build the funds needed to negotiate with your creditors. This money accumulates until it’s used to pay off your debts.

6. Debt settlement company negotiates with creditors

The debt settlement company will negotiate with your creditors on your behalf. Their goal is to get creditors to settle your debts for less than what you owe. This could involve several rounds of negotiations and may take some time. Many people settle their first debt within a few months after starting the program. The entire program could be complete in as little as two to four years. 

7. Creditors agree to settlement offers

Creditors often agree to reduce the amount you owe if they believe it's the best way to recover part of the debt. Once the debt settlement company reaches an agreement with a creditor, they will offer it to you for approval.

8. Authorize settlement agreements

Once you approve a settlement offer, the creditor is paid from your dedicated account. Your debt settlement fees will be paid from the same account. Federal law prohibits debt settlement companies from charging debt settlement fees in advance. You should only pay once an agreement is reached with a creditor, you approve the agreement, and at least one payment has been made toward that agreement. 

9. Continue to reduce debt as agreements are reached

The debt settlement company is unlikely to reach agreements with creditors all at once. These agreements are more likely to happen one-by-one over several months. As agreements are reached, your creditors are paid from your dedicated account. Each time this happens, you’ll be one step closer to being debt-free.

10. Debts are marked as settled on credit reports

Once payments are made, your debts could be marked as settled on your credit reports. Paying less than you owe is likely to hurt your credit score at first. In the long run though, resolving those debts could allow you to start building a better financial future.

11. Complete the program and exit debt settlement

After all agreed settlements are paid, you’ll complete the debt settlement program. At this point, both the number of debts you have and the total amount you owe should be reduced, or even eliminated. Completing this process is a significant milestone toward financial stability.

How Debt Settlement Affects Your Credit

Negotiating debts doesn’t affect credit. But many people who are thinking about doing debt settlement have already fallen behind on debt payments. Other people might choose to stop paying their debts when they decide to pursue debt settlement. Missed payments on credit accounts get reported to credit bureaus and typically cause the borrower’s credit score to decline. 

Just like other negative items on your credit history, debt settlement will show up on your credit report. Late payments stay on credit reports for seven years from the first delinquency. Settled accounts appear as “settled,” not “paid as agreed.” But the balances on these accounts show as zero once settled, which is typically better for your credit than leaving accounts in collections. 

If you’re already behind on your credit card bills, overdue on other personal debts, or struggling to manage high balances on your credit accounts, chances are that your credit score has already taken a hit. This is especially true for people in financial hardship like a serious medical event or long-term job loss. 

During times of serious financial trouble, focusing on your financial recovery and stability matter more than short-term credit changes. Dealing with your debt with a debt settlement program could put you in a better position to build and maintain good credit in the future.

Freedom Debt Relief is not a Credit Repair Organization and does not provide or offer services or advice to repair, modify, or improve your credit.

Debt Settlement Benefits and Considerations

Debt settlement can be a beneficial solution for people with serious debt problems. But it’s critical to understand the details, limits, and possible consequences. 

Benefits of debt settlement

• Potential debt reduction through negotiated settlements.

• Streamlined single monthly payment can free up extra cash in your budget.

• As little as two to four years to resolve all eligible debts.

• Could help you avoid bankruptcy. 

• Professional debt settlement programs give you experienced debt experts to help you through the process 

Key considerations

• Credit scores are likely to decline during the debt settlement program.  

• Enrolling in a debt settlement program requires genuine financial hardship.

• Consistent monthly deposits (to save up money for settlement offers) are essential for success. 

• Creditors are under no obligation to negotiate. You could be sued for delinquent debts—a debt settlement program doesn’t protect you from lawsuits.  

• Forgiven debt could be considered taxable income unless you’re insolvent when you settle the debt. Insolvent means the amount you owe is greater than the value of the things you own.  

If you’re going through serious financial hardship, have already fallen behind on your bills, are getting calls from debt collectors, or are at risk of missing payments on credit cards or other debts, debt settlement might be a good choice for your financial situation. Be prepared for possible consequences for your credit score, your credit report, and possibly your tax return. 

What Types of Debt Qualify for Debt Settlement?

Debt settlement is only an option for unsecured debts, like credit cards, store cards, medical bills, some private student loans, and most unsecured personal loans and personal lines of credit. 

With unsecured debts, if a debt goes overdue or unpaid, creditors don’t have anything of value to fall back on. This makes unsecured debts more risky for lenders. And when faced with the risk of not getting paid at all, creditors and lenders might be willing to do debt settlement for overdue unsecured debts. They might decide that settling an unsecured debt for a smaller amount of money is better than nothing (or spending the time and money to sue you, with no guarantee of success).

Secured loans, like mortgages and auto loans, aren't eligible for debt settlement, since the lender can repossess the vehicle or foreclose on the home to recoup its losses. For these loans, lenders don’t need to negotiate about unpaid debts. Instead, creditors have the right to take the property that secured the unpaid loan. Federal student loans, tax debts, domestic support, criminal restitution (such as debts caused by getting a DUI) are also generally excluded from debt settlement programs.

Debt settlement isn’t a legal right, and it doesn’t give you legal protections like filing bankruptcy. And debt settlement isn’t guaranteed to be the best fit for every debt problem. Creditors don’t have to settle your debts. But many creditors will consider negotiating debts for borrowers who are experiencing genuine financial hardship.

The 4-Step Freedom Debt Relief Settlement Process 

In the Freedom Debt Relief program, debt settlement takes four steps, but keep in mind that other debt settlement companies may work differently.

1. Build funds for settlements

Once you enroll in the Freedom Debt Relief program, the first step is for you to build up funds that will be used to pay creditors for settlements we negotiate on your debts. You will make a monthly deposit into a dedicated account.  

The amount of money you need to deposit into this account each month is customized to fit your budget, and is often much lower than your minimum payments to creditors. That means that as soon as you enroll, you could notice an immediate increase in your available cash each month.

2. Negotiate with creditors 

Once the funds in the account have grown large enough, our negotiation experts begin reaching out to your creditors to find out if they are willing to settle for less than the full amount owed to consider your debt paid. One of the reasons why creditors are willing to accept a reduced amount is because individuals in our program have experienced financial hardship.

Freedom Debt Relief has been negotiating with creditors since 2002, and we use this experience to create a custom strategy and negotiation timeline for each of our clients. Over half of our clients get their first debt settled within 90 days of making their first deposit. 

3. Authorize settlements 

As soon as your creditor agrees to a settlement, we email and text you to share the details. Once you authorize a settlement, payment is processed from your FDIC-insured account to the creditor. The settlement payment may be one lump-sum amount, or it may be structured into multiple payments over time. 

Negotiation fees are processed from the same account to Freedom Debt Relief for that specific debt. The fee is based on the amount of debt enrolled into the program and is calculated into your monthly deposit. These fees are set and will never increase.

4. Celebrate financial freedom  

When the settlement has been paid in full, the creditor considers your debt fully resolved, and you can officially put it in your past!

This process repeats for all the debts enrolled in the program until each one of them has been resolved. At this point, you graduate from the program free of the debts you enrolled and in a much stronger place financially. 

DIY Debt Settlement vs. Professional Help

If you’re organized, good at being proactive, standing up for yourself, and having conversations with creditors, it’s possible to use DIY debt settlement to negotiate debts by yourself. Settling debts by yourself can be a solid choice, but professional debt settlement help could be a better option for people who aren’t ready to tackle this process on their own. 

Here’s a quick breakdown for choosing DIY debt settlement vs. professional debt settlement help. 

DIY debt settlement 

This type of debt settlement could be best for people who: 

• Are comfortable having sometimes tough conversations with creditors and debt collectors 

• Can set aside money each month to save up extra cash for debt settlement offers

• Are organized at managing their own communication, documentation, and other details with creditors  

Professional debt settlement 

Professional debt settlement programs could be best for people who: 

• Want expert help and an existing process to manage creditor contact and organize settlements

• Prefer structured support with an organized plan and a dedicated account to save up cash for settlement offers

• Want professional negotiators with established industry experience and relationships with creditors

Whichever path you choose for debt settlement, remember that you have rights and you have options. You’re allowed to ask creditors to accept a settlement offer. DIY debt settlement could help you get a better deal for your financial situation. If you’d rather not take on such complex details and challenging conversations by yourself, a professional debt settlement company can take these tasks off your to-do list.

Have Questions? We Are Here With Answers! 

To learn more about debt settlement and find out if it’s the right solution for you, give one of our Certified Debt Consultants a call at 800-910-0065 or click here to get started. We can assess your situation to determine how soon Freedom Debt Relief could help you put your debts behind you.