Is debt settlement a good idea?

More U.S. consumers may need help managing their credit card payments. Roughly 6.9% of credit card users were in serious delinquency in the first quarter of 2024 — the highest rate since historic lows in 2021 — according to the Federal Reserve’s latest quarterly report on household debt and credit, released in May.

If you’re behind on your credit card payments and looking for a solution, you might be considering debt settlement, which promises to help clear your debts. However, debt settlement is risky and should be a last resort for most borrowers.

How does debt settlement work?

Debt settlement is the process by which your debts are settled for less than you owe. Though you can settle debts yourself, many borrowers hire a for-profit debt settlement company.

Here’s how it works: A debt settlement company will ask you to stop making payments on your debts and instead funnel that money into an escrow account, which is a separate account set up by the settlement company. As your debts become increasingly delinquent, the settlement company will approach your creditor with an offer, using the money in the escrow account. Ideally, the creditor accepts the offer, with the thinking that some money is better than none. Then, your debt is cleared for the lesser amount.

Debt settlement isn’t free. Debt settlement companies may charge a fee of 15% to 25% of the amount you owe for each successful settlement. For example, if you owe $10,000 and the debt settlement company charges a fee of 25%, you’ll pay a $2,500 fee (in addition to the settled amount).

The average debt settlement client saves $1,440 after fees, or 31.9% of their debt burden, according to a 2023 economic impact report commissioned by the American Association for Debt Resolution.

Risks of debt settlement

Though debt settlement may sound promising, it can be a “very bumpy road,” warns Bryce McNitt, chief of staff for market offices at the Consumer Financial Protection Bureau. Settling your debts can take two to four years, and there are serious consequences to falling that far behind on payments.

“You very well could be in collections at that point, and your credit score will dive down,” McNitt says. “You could also face pressure tactics from collectors. If you're getting calls, if you’re getting a lawsuit, that’s very stressful.”

As interest and fees from your creditor pile up, you’re reducing any potential savings that debt settlement promises.

There’s also no guarantee a company can settle your debt. Some creditors won’t accept a debt settlement offer or work with debt settlement companies. Any debts you successfully settle may further hurt your credit score, since settled accounts stay on your credit report for up to seven years.

Other ways to tackle overwhelming debt

There are other, less-risky ways to get credit card debt under control.

Financial experts widely recommend debt management plans. These plans are offered by nonprofit credit counseling agencies and roll multiple unsecured debts into one at a lower interest rate, which makes the debt easier to pay off.

Though debt management plans may temporarily lower your credit score, successfully paying down your debt can help your score, says Justin Botimer, partner development manager at GreenPath Financial Wellness, a nonprofit credit counseling agency. Debt management plans also have lower fees, but many people don’t know about them, he says. 

“The reality is our industry doesn't have the big budgets that for-profit companies have,” Botimer says. “We hear all the time, ‘I wish I would have known about you sooner.’ This is after they’ve been wrangled into debt settlement.”

A debt consolidation loan is another alternative. You use the money from a loan to pay off your debts in one fell swoop, then pay back the new loan in fixed monthly installments, ideally at a lower interest rate. But debt consolidation loans can be tough to qualify for, because you need a strong credit score.

Bankruptcy may be an option for people whose debt payments account for a significant portion of their income. Though it may temporarily hurt your credit, bankruptcy can protect you from aggressive action from creditors, like lawsuits or wage garnishment.