• Skip to primary navigation
  • Skip to main content
  • Skip to primary sidebar
  • Skip to footer

The College Investor

Student Loans, Investing, Building Wealth

  • About
  • Podcast
  • Research
  • Contact
  • Save For College
      • How To Start

      • How To Save For College
      • How To Pay For College
      • What Is the Average Cost of College?
      • What Is A 529 Plan and Where to Open One in Your State
      • How Much Should You Have In A 529 Plan By Age
      • How To Use A 529 Plan For Private Elementary And High School
      • What Are Qualified Expenses For A 529 Plan (And What Doesn’t Count)?
      • The Best Brokers To Open A 529 Plan
      • Tools + Accounts

      • 529 Plans: The Ultimate College Savings Plan
      • 529 Plan Contribution Limits
      • Prepaid Tuition Plans | What To Know
      • Understanding And Using 529A ABLE Accounts
      • Using A Roth IRA To Save And Pay For College
      • FAFSA Deadlines for Financial Aid
      • CollegeBacker Review
      • Upromise Review
      • UNest Review
      • Other Options

      • Student Loan And Financial Aid Programs By State
      • The Guide To Military And VA Education Benefits
      • How To Fill Out The FAFSA
      • How To Find College Scholarships
      • The Best College Scholarship Search Websites
      • How To Find Grants To Pay For College
      • Pell Grants: What They Are And How To Qualify
      • Understanding Federal Work-Study
      • How To Use A 529 Plan If Your Child Doesn’t Go To College
  • Student Loans
      • Borrowing

        • How Student Loans Work
        • How To Apply For A Student Loan
        • Best Student Loans And Rates In January 2023
        • 10 Best Private Student Loans Of January 2023
        • Best Student Loans To Pay For Graduate School
        • Best Student Loans To Pay For Medical School
        • Parent Loans To Pay For College
        • No-Cosigner Student Loan Options
        • Guide To Income Sharing Agreements (ISAs)
        • Best International Student Loans
      • Get Out Of Debt

        • Best Student Loan Refinance Companies In January 2023
        • Best Student Loan Repayment Plans
        • Best Student Loan Refinancing Bonuses And Promotional Offers Of January 2023
        • Student Loan Forgiveness Programs (The Complete List)
        • The Full List Of Student Loan Forgiveness Programs By State
        • Public Service Loan Forgiveness (PSLF)
        • Top Student Loan Scams
        • Average Student Loan Monthly Payment
        • Average Student Loan Debt By Year
      • Reviews

        • Credible Review
        • Splash Review
        • Ascent Review
        • Citizens Bank Review
        • Commonbond Review
        • Earnest Review
        • ELFI Review
        • Laurel Road Review
        • LendKey Review
        • SoFi Review
  • Investing
      • How To Start

        • How To Start Investing in High School
        • How To Start Investing In College
        • How To Start Investing In Your Twenties For 22 – 29 Year Olds
        • How To Start Investing In Your 30s For 30 – 39 Year Olds
        • How To Start Investing With $100 Or Less
        • How To Give Kids The Gift Of Stock
        • What Is Dividend Growth Investing
        • IRA Rollover Chart
      • Tools + Accounts

        • Best Online Stock Brokers
        • The Best Traditional And Roth IRA Accounts
        • The Best Robo-Advisors
        • The Best Investing Apps
        • The Best Places to Trade Options
        • The Best Places To Open A Health Savings Account
        • The Best Solo 401k Providers
        • The Best Self-Directed IRA Providers Of 2023
        • Best Cryptocurrency Exchanges
      • Reviews

        • Vanguard Review
        • Fidelity Review 2023
        • M1 Finance Review
        • TD Ameritrade Review 2023
        • Charles Schwab Review
        • Robinhood Review
        • Webull Review
        • Betterment Review 2023
        • Wealthfront Review
  • Earn More Money
      • Extra Income

        • 20 Best Side Hustles You Can Start Earning With In 2023
        • 53 Side Hustle Ideas To Make Money Fast
        • 100 Ways To Make Money In College
        • 80 Ways To Make Money From Home In 2023
        • 5 Quick Money Making Ideas (That Take Less Than 1 Hour)
        • 10 Interesting Ways You Can Make Money Driving
        • High-Paying Side Gigs That Earn $1,000 or More Per Month
        • The 10 Best Money-Making Apps
        • Paid Surveys: Earn Money For Giving Your Opinion Online
        • 10 Crazy Ways To Make $10,000 You’ve Never Heard Of
      • Build Wealth

        • 40 Passive Income Ideas You Can Use To Build Wealth In 2023
        • 3 Ways To Make $50,000 Per Year Without Working With Passive Income
        • How To Become A Real Estate Investor With Just $500
        • 15 Best Online Business Ideas
        • Residual Income: 7 Super Smart Ways to Build It
        • The Most Common Multiple Income Streams
        • How To Become A Real Estate Mogul With Only $10,000
      • Reviews

        • Fundrise Review
        • RealtyMogul Review
        • FarmTogether Review
        • AcreTrader Review
        • Swagbucks Review
        • Survey Junkie Review
        • TopCashback Review
        • DoorDash Review
  • Personal Finance
      • Banking

        • 10 Best High Yield Savings Accounts Of January 2023
        • 10 Best Money Market Accounts Of January 2023
        • 10 Best Free Checking Accounts In January 2023
        • Best Bank CD Rates Of January 2023
        • 10 Best Business Checking Accounts In January 2023
        • Best Online Banks Of January 2023
        • Best Credit Unions Nationwide Of January 2023
        • Best College Student Checking Accounts Of January 2023
      • Insurance

        • Best Life Insurance Companies
        • Renters Insurance
        • Car Insurance
        • Pet Insurance
        • Umbrella Insurance
        • Disability Insurance
        • Tuition Insurance
        • Travel Insurance
      • Credit Tools

        • Best Budgeting Apps
        • Cash Advance Apps
        • How To Get A Free Credit Score Report
        • Best Credit Monitoring Services For 2023
        • Debt Settlement: Inside The Secret World
        • Credit Repair Explained: Should You Pay For Help?
        • Best Personal Loan Companies And Lenders
        • Online Loan Companies To Borrow From Home
      • Tax

        • Best Tax Software
        • Free Tax Software
        • IRS Tax Refund Calendar
        • Common IRS Questions and Errors
        • Federal Tax Brackets
        • Capital Gains Tax Brackets
        • 401k Contribution Limits
        • IRA Contribution Limits
        • HSA Contribution Limits
  • Forum
  • Search
Home » Money » Get Out Of Debt » Debt Settlement: Inside The Secret World Of Debt Consolidation

Debt Settlement: Inside The Secret World Of Debt Consolidation

Updated: December 12, 2022 By Ben Tejes

Tweet
Share
Share
Pin
Email
Print

At The College Investor, we want to help you navigate your finances. To do this, many or all of the products featured here may be from our partners. This doesn’t influence our evaluations or reviews. Our opinions are our own. Any investing information provided on this page is for educational purposes only. The College Investor does not offer investment advisor or brokerage services, nor does it recommend buying or selling particular stocks, securities, or other investments. Learn more here.Advertiser Disclosure

There are thousands of financial products and services out there, and we believe in helping you understand which is best for you, how it works, and will it actually help you achieve your financial goals. We're proud of our content and guidance, and the information we provide is objective, independent, and free.

But we do have to make money to pay our team and keep this website running! Our partners compensate us. TheCollegeInvestor.com has an advertising relationship with some or all of the offers included on this page, which may impact how, where, and in what order products and services may appear. The College Investor does not include all companies or offers available in the marketplace. And our partners can never pay us to guarantee favorable reviews (or even pay for a review of their product to begin with).

For more information and a complete list of our advertising partners, please check out our full Advertising Disclosure. TheCollegeInvestor.com strives to keep its information accurate and up to date. The information in our reviews could be different from what you find when visiting a financial institution, service provider or a specific product's website. All products and services are presented without warranty.

debt settlement

You may have recently experienced a financial hardship and are strongly considering consolidating your debts to relieve some pressure. Before bankruptcy, there are two main debt consolidation options to consider.

The first is a debt consolidation personal loan. This is often for those who still have a good credit score and debt-to-income (DTI) ratio. The second is debt consolidation via debt settlement, which is what we will cover today.

The debt settlement industry has had many companies that have been unscrupulous. In fact, the Consumer Financial Protection Bureau (CFPB) has repeatedly warned borrowers that dealing with debt settlement companies can be risky. Does that mean that all of these companies are bad and you should never work with one?

In this article, we'll look at how debt settlement works, its pros and cons, and the most commons scams and red flags of unethical debt settlement companies. Here's what you need to know.

Table of Contents
How Debt Settlement Works
Understanding The Debt Settlement Process
Your Actual Debt Settlement Results
Understanding The Actual Results
Downsides Of Debt Settlement
Common Scams And Red Flags Of Debt Settlement Companies
Final Thoughts

How Debt Settlement Works

Because there will be negative side effects, you may want to consider all of your credit card debt relief options before pursuing debt settlement. If you haven’t already, you may also want to put together a budget to see whether there are expenses that can be reduced to avoid debt relief altogether.

Debt settlement (also known as debt consolidation via debt settlement) is the process of negotiating your debts for a lesser amount. It’s not to be mistaken for debt management, which is the process where a company would try to negotiate lesser interest rates or a modified repayment plan.

Understanding The Debt Settlement Process

When you enroll in a debt settlement program, the company you choose will work as the intermediary between the individual and the creditor. Here’s generally how the process works:

  1. 1
    You will create an enrollee-owned escrow bank account where all of your funds are added. This bank account is yours, but you give them access to settle accounts with your permission. You have the right to agree or decline a settlement offer.
  2. 2
    You then send one or two draft amounts to this bank account each month instead of that money going to your creditors.
  3. 3
    The company you choose will act as the primary contact between the creditors and you. Once funds accrue, the debt settlement company will generally begin negotiating with each creditor.
  4. 4
    The debt settlement company will negotiate with a creditor based on financial hardship.
  5. 5
    When a settlement is tentative, you will have the opportunity to accept or reject the plan. The plan may call for a one-time payment or monthly payments for up to 24 months. Creditors may provide better rates for one-time payments because the creditors prefer to get as much money as they get in the door immediately.
  6. 6
    You will go through this same process again and again with the debt settlement company until all of the debts have been negotiated and settled.

Once each plan has been completed, you will graduate from the program -- hopefully totally debt-free.

Your Actual Debt Settlement Results

The biggest downside to working with a debt settlement company rather than negotiating your debts yourself is that you'll have to pay fees for their service which will reduce your actual savings. Before you join any program, you should have correct expectations of how much it will cost you and how much you can save. 

The savings can be significant. But it’s also possible that you won’t save much at all, especially after the fees you'll pay to the debt settlement company have been taken into account. Here's how to weigh to perform your own cost/benefit analysis.

Understanding The Costs

Debt settlement companies generally charge for their programs as percentage of enrolled debt or as a percentage of the savings they provide. The most common method is the percentage of enrolled debt. A company that charges a percentage of savings may look for those individuals who have equity in other assets that will allow them to lump together all of the settlements.

  • The fee for the percentage of enrolled debt programs often ranges from 15 - 25%.
  • In addition, you will often be charged an escrow account fee of $12 - $15 per month.
  • You will also often have the option to get legal coverage in case of a lawsuit that ranges from $10 - $50 per month. 

A debt settlement program should negotiate your debt for you if there is a lawsuit. In short, you should not need a lawyer to negotiate on debt with a lawsuit if you're already working with a debt settlement company. But if you do, you generally would pay in the range between $175 - $300 per hour in legal fees.

Below is a breakdown of three monthly scenarios to help you understand how much you will save. This scenario assumes a 50% blended debt reduction, 15% program fee, and $12.50 monthly escrow fee. 


Program Length


36 Months


48 Months


60 Months

Debt

$30,000

$30,000

$30,000

Settled Amount

$15,000

$15,000

$15,000

Program Fees

$4,500

$4,500

$4,500

Escrow Fees

$460

$610

$760

Monthly Payments

$554.43

$418.95

$337.66

Total Paid

$19,960

$20,110

$20,260

Total Estimated Savings

$10,041

$9,891

$9,741

Below is a similar breakdown estimate, but this time the program fee is 25%. You see that you’ll end up paying around $3,000 more in fees in this scenario.


Program Length


36 Months


48 Months


60 Months

Debt

$30,000

$30,000

$30,000

Settled Amount

$15,000

$15,000

$15,000

Program Fees

$7,500

$7,500

$7,500

Escrow Fees

$460

$610

$760

Monthly Payments

$637.76

$481.45

$387.66

Total Paid

$22,960

$23,110

$23,260

Total Estimated Savings

$7,041

$6,891

$6,741

You may still save money when comparing your current monthly payments to the estimates above. But it may be less than originally anticipated.

Also, there are some legal groups that I have seen that charge up to 35% of enrolled debt with additional fees. In this scenario, you may want to estimate how much you’ll be paying to see whether you'll save anything at all.

Understanding The Actual Results

Let’s get granular on a specific example. Many debt settlement companies will quote a 50% debt reduction. But it may fail to mention the fees that you will be paying for its services.

To illustrate this point, let’s say you have $20,000 in debt and the company you chose negotiates for $10,000 over 36 months. The company charges you 25% of the debt enrolled as a fee. You also have to pay a $12.50 escrow account maintenance fee per month.

Let’s also say that you are "solvent" as defined by the IRS. Assuming a 25% income bracket, you only saved $2,050 ($20,000 - $10,000 - $5,000 - $2,500 (25% * Forgiven Debt) - $450).

This may still be a better scenario than the alternative. But projecting your actual results can be helpful before you join a program to compare to other debt-relief options.

Downsides Of Debt Settlement

In addition to the fees that you'll pay, here are a few more disadvantages of working with a debt settlement company.

Potential Tax Implications

If you are solvent as defined by the IRS, you may receive a 1099-C from the IRS for the forgiven debt. The creditor may submit these canceled debt savings to the IRS when the amount is forgiven is greater than $600. Now you may still save money with debt settlement, but this is an important thing to consider.

Do you always have to pay taxes on forgiven debt? Not necessarily. If you are tax insolvent as defined by the IRS, you may not have to pay taxes on forgiven debt, but this is a better question for a tax advisor

Related: Student Loan Forgiveness And Insolvency

Credit Score Implications

Your credit score will undoubtedly take a tumble. How much you may ask? It often depends on your starting point. The best way to answer this question may be to use myFICO’s free credit score estimator to approximate your score drop based on your personal details.

When debt is settled, the creditor may report it as “paid in full for less than the full balance” rather than charged-off, which would hurt your score less. That said, it’s always better from a credit report perspective to get the "debt paid in full" mark.

Legal Implications

The chances of a lawsuit are probably one of the most important factors to consider before pursuing debt settlement. This is often not spoken about before starting the program. The CFPB says that working with a debt settlement company can increase your risk of being sued for your debts.  

A debt settlement program will generally still be able to negotiate with a creditor even after a lawsuit although the fees are often higher which will reduce your savings. Some programs may offer a legal assistance option if you are sued. But again this will increase your total fees paid.

Beyond the monetary cost, being sued is extremely stressful and can take a huge emotional toll as well.

Common Scams And Red Flags Of Debt Settlement Companies

There are many common red flags and scams to consider before pursuing debt consolidation via debt settlement. Here are three warning signs that you'll want to watch out for.

Few Reviews On Unbiased Review Sites

When you search for specific debt settlement companies, you may find biased and unbiased review sites. Relatively unbiased review sites would include Google, Yelp, or TrustPilot because any customer can share their opinions.

However, you'll want to be more careful with editorial reviews on debt consolidation blogs and sites. The reason is that debt settlement companies may pay these review sites handsomely to secure their glowing remarks and high ratings. You'll want to do your due diligence across multiple review sites before choosing a program.

Charges Upfront Fees

Many years ago, companies would charge large upfront fees before ever settling debts. These companies would take advantage of people by charging fees and never settling a debt.

Thankfully, the Dodd-Frank Act put restrictions on upfront fees. Most debt companies will only charge the program fee after a debt is settled. That said, you may want to make sure that whichever company you're choosing follows the legal guidelines. 

Doesn't Fully Analyze And Discuss Your Lawsuit Risk

There are some creditors that have a higher likelihood of suing than other creditors. When you have 10 creditors, a debt settlement company should know the lawsuit likelihood of each of your creditors based on previous data.

If 1 of the 10 debts has a high likelihood of a lawsuit, then it may be okay to enroll in a program as the debt settlement company should prioritize that debt. But if 9 out of 10 creditors have a high likelihood of a lawsuit, you may want to consider a different debt relief option.

Final Thoughts

Before pursuing debt settlement, you'll want to carefully weigh the pros and cons. When you are considering a specific firm, it may also be good to check with your state’s attorney general and consumer protection office to see if the company you're considering has any outstanding complaints.

Remember, negotiating a debt settlement on your own could save you the most money since you won't have to deduct any fees from your savings. Also, creating a debt management plan (DMP) with a NFCC-certified credit counselor could be a better option as it could relieve your debt pressures while also preserving your credit score and steering you clear of lawsuits.

Finally, you may want to consider starting a side hustle to increase your income while you're in debt-payoff mode. If you're looking for a side hustle that can earn you extra money quickly, here are 53 ideas to consider.

Ben Tejes
Ben Tejes

Ben is a personal finance writer with a background in consulting, high-tech, and fintech startups. He also manages a small finance technology company called Ascend Finance that focuses on helping people get out of debt by providing unbiased information about different options. He enjoys covering topics such as budgeting, debt freedom techniques, and fintech. He also writes at his own blog, Saved By The Cents.

In his free time, Ben enjoys spending time with his three young daughters and exploring new hikes.

Debt Settlement: Inside The Secret World Of Debt Consolidation

Editor: Clint Proctor

Editorial Disclaimer: Opinions expressed here are author’s alone, not those of any bank, credit card issuer, airlines or hotel chain, or other advertiser and have not been reviewed, approved or otherwise endorsed by any of these entities.
Comment Policy: We invite readers to respond with questions or comments. Comments may be held for moderation and are subject to approval. Comments are solely the opinions of their authors'. The responses in the comments below are not provided or commissioned by any advertiser. Responses have not been reviewed, approved or otherwise endorsed by any company. It is not anyone's responsibility to ensure all posts and/or questions are answered.
Subscribe
Connect with
I allow to create an account
When you login first time using a Social Login button, we collect your account public profile information shared by Social Login provider, based on your privacy settings. We also get your email address to automatically create an account for you in our website. Once your account is created, you'll be logged-in to this account.
DisagreeAgree
Notify of

I allow to create an account
When you login first time using a Social Login button, we collect your account public profile information shared by Social Login provider, based on your privacy settings. We also get your email address to automatically create an account for you in our website. Once your account is created, you'll be logged-in to this account.
DisagreeAgree

0 Comments
Inline Feedbacks
View all comments

Primary Sidebar

Robert Farrington will teach you how to get out of student loan debt and how to start investing.

Hi! My Name is

America's Millennial Money Expert

Welcome to The College Investor. We're here to help you escape student loan debt so you can start investing and building wealth for the future

Our expert guides, reviews, and more are designed to help you achieve your financial goals.

Want to learn more? See what's in my wallet.

As Featured In

Social Media

Popular Posts

Side Hustling

53 Side Hustle Ideas To Make Money Fast

Best Side Hustles

20 Best Side Hustles You Can Start Earning With In 2023

Crazy Ways To Make $10,000

10 Crazy Ways To Make $10,000 You’ve Never Heard Of

Make $50,000 Per Year

3 Ways To Make $50,000 Per Year Without Working With Passive Income

Student Loan Scams

Top Student Loan Scams

Net Worth of Millennials

Average Net Worth Of Millennials By Age

Ways To Get Student Loan Forgiveness

Student Loan Forgiveness Programs (The Complete List)

529 Plan By Age

How Much Should You Have In A 529 Plan By Age

Passive Income Ideas

40 Passive Income Ideas You Can Use To Build Wealth In 2023

Make Money From Home

80 Ways To Make Money From Home In 2023

Ultimate Guides

529 Plan Guide

529 Plans: The Ultimate Guide To College Savings Plans

Student Loans and Financial Aid By State

Student Loan And Financial Aid Programs By State

Student Loan Advice

The Definitive Guide To Student Loan Debt

Student Loan Forgiveness By State

The Full List Of Student Loan Forgiveness Programs By State

newretirement

How to Start Saving Now: The College Graduate’s Guide to Saving for Retirement

Latest Research

How much to file taxes

Tax Survey: How Much People Paid To File And The No.1 Tax Software They Used

Inflation survey

Side-Hustles To The Rescue: Survey Shows 86% Stressed About Money & Inflation

students choose to work survey

75% Of Students Would Still Choose To Work Even If They Didn’t Have To

Institutional Merit Grants

Who Gets Institutional Merit Grants At Private Colleges?

Resume Student Loan Payments

Survey: Even With Higher Expenses, Most Student Loan Borrowers Are Ready To Resume Payments

Footer

Who We Are

The College Investor is an independent, advertising-supported financial media publisher, focusing on news, product reviews, and comparisons.

Connect

  • Contact Us
  • Advertise
  • Press & Media

About

  • About
  • Our Team
  • Podcast
  • Editorial Guidelines
  • How We Make Money
  • Archives

Social

Copyright © 2023 · The College Investor · Privacy Policy ·Terms of Service · DO NOT Sell My Personal Information

wpDiscuz