What does debt settlement mean?

When you're having trouble keeping up with your payments on a past-due debt, you might be considering debt settlement as a way to get relief. Debt settlement is an agreement between you and your creditor to pay off your debt for less than what you originally owed.

However, if you don't choose the right settlement company, or try to negotiate directly with your creditors yourself, the process could backfire and you could end up owing even more money. Read on to learn more about how debt settlement works, the potential risks involved, and other options you might want to consider instead.

What Is Debt Settlement?

Debt settlement is when you and your creditor agree to a lump-sum payment that's less than the full amount you owe to settle your debt.

Your creditor may agree to a debt settlement if:

You're having trouble making your minimum monthly payments.
Your account is delinquent or past due.
Your creditor thinks you might default on your debt (fail to pay it back at all).

Once you and your creditor agree on a settlement amount, you'll usually have to pay the lump sum all at once. If you can't come up with the money to pay the lump sum, you might be able to work out a payment plan with your creditor.

How Does Debt Settlement Work?

Debt settlement companies typically ask you to stop making payments on your debts and instead start making monthly deposits into a dedicated account. Once the account has enough money saved up, the debt settlement company will negotiate with your creditors to try to get them to agree to accept the lump sum in full payment of your debt. If the negotiation is successful, the debt settlement company will pay your creditors from the account and charge you a fee for their services, which can be a percentage of the amount saved or a flat fee.

What Are The Benefits Of Debt Settlements?

There are a few potential benefits of debt settlement, including:

You could save money on your overall debt if your creditors agree to accept less than what you originally owed.
Your credit score won't be as negatively affected as it would if you declared bankruptcy or didn't make any effort to repay your debt.
You might be able to get out of debt more quickly than if you stuck to making minimum monthly payments.
You'll only have to make one payment to the debt settlement company each month, which can be easier to manage than making multiple payments to different creditors.
You might be able to negotiate a payment plan with the debt settlement company so you don't have to come up with the lump sum all at once.

What Are The Risks Of Debt Settlement?

There are also some potential risks to be aware of before entering into a debt settlement agreement, including: