Debt settlement pros and cons: Is it right for you?

Picture this: You’re staring at a stack of credit card bills but are only able to make the minimum payments on the accounts, which barely touch the balance. As a result, you’re watching the interest charges pile up faster than you can pay them down. Sound familiar? It might. Millions of people find themselves trapped in this cycle every year, and the issue is only getting worse now that the average credit card rate is sitting near a record high.

When this happens and the traditional credit card repayment strategies aren’t enough, debt settlement often comes up as a possible solution. Unlike debt consolidation or balance transfers, which simply help combine multiple debts into one account and interest rate, debt settlement involves negotiating with creditors to settle for less than what you owe. It’s a strategy that can cut your total credit card debt significantly, but it’s also one that fundamentally changes your relationship with credit and can reshape your financial future in ways you might not anticipate.

So, the question isn’t whether debt settlement works. It does in many cases. The real question is whether the relief it provides outweighs the long-term consequences. Below, we’ll examine what you need to know to determine that.

Chat with a debt relief expert about your options now.

Debt settlement pros and cons: Is it right for you?

Here’s a look at the pros and cons of debt settlement to help you decide whether this approach makes sense in your situation.

Pro: You could pay significantly less than you owe

The most obvious benefit of debt settlement is the potential to pay substantially less than what you owe currently to get rid of your credit card debt. Successful settlements often reduce debt by 30% to 50%, though results vary. So, if you owe $20,000 across several credit cards, a settlement might reduce that to between $10,000 and $14,000 before fees. For someone facing serious credit card debt issues, this type of debt reduction can be life-changing.

Find out how to start the debt settlement process today.

Pro: It could be a smart alternative to bankruptcy

For those with overwhelming amounts of credit card debt, debt settlement can be a good alternative to bankruptcy. While both options damage your credit, bankruptcy appears on your credit report for up to 10 years, compared to seven years for settled accounts. 

Debt settlement also allows you to maintain more control over the process, and if successful, you can resolve your debt issues without going to court, liquidating your assets or dealing with a bankruptcy trustee. For some people, that alone makes settlement worth considering.

Pro: It could be a path to faster debt resolution

When debt settlement works, it can resolve your debt problems much faster than making just the minimum payments on what’s owed. Instead of taking decades to pay off high-rate credit card balances, the average debt settlement process is completed within two to four years. This expedited timeline can help free up cash flow for other financial goals and provide psychological relief from the burden of long-term debt.

Con: It could come with credit score damage

Debt settlement typically involves you stopping payments on your accounts as you save up to fund negotiated settlements, which immediately damages your credit score. Delinquent accounts can result in negative marks that drop your score by 100 points or more, and this damage can impact your ability to qualify for mortgages, car loans or even rental apartments.

Settling your accounts for less than what you owe can also have an impact on your credit score, and these types of negative marks remain on your credit report for seven years from the original delinquency date. During that time, any credit you do qualify for will likely come with higher interest rates and less favorable terms.

Con: There is no guarantee of success

While working with an experienced debt relief expert can increase your chances of success, there is no guarantee that creditors will accept the proposed settlement offers. Some creditors, particularly those who believe you have the ability to pay, may refuse to negotiate and instead pursue collection actions or lawsuits. That’s why many debt settlement companies offer their customers access to legal service providers who can help navigate these issues. Most companies charge customers an additional fee for this service, though some offer it at no additional cost. 

That means you could end up with damaged credit and still owe the full balance. The process can also take years to complete, during which your debt continues to grow due to interest and penalties. And if the settlement ultimately fails, you may owe more than when you started.

Con: There could be tax implications and fees

Forgiven debt above $600 is typically considered taxable income by the Internal Revenue Service (IRS). If you settle a $15,000 debt for $7,500, you may owe taxes on the $7,500 difference. This “phantom income” can create an unexpected tax bill, especially problematic when you’re already struggling financially.

Settlement companies also charge fees, which typically range from 15% to 25% of your enrolled debt. So, on a $20,000 debt load, you might pay $3,000 to $5,000 in fees, reducing the actual benefit.

The bottom line

Debt settlement can provide relief for those facing overwhelming debt, but it’s not a decision to make lightly. The credit damage can be significant and long-lasting, and there’s no guarantee the process will succeed. Before pursuing settlement, it’s important to exhaust other options and speak with an expert who can help you evaluate both debt settlement and all of your alternatives. That way, you can ensure that the decision you’re making is right for your unique circumstances.