What is Debt Settlement?

Debt settlement is a process in which you typically work with a third-party service (most often for-profit) to negotiate with your creditors to reduce the total amount you owe for your debt and in its place, pay a “settlement”.


This settlement payment is typically made in a lump sum all at once to clear your debt with the creditor at the negotiated lower price point.

DIY Debt Settlement

Many people don’t know this, but you can do everything debt settlement companies do by yourself. There’s nothing stopping you from contacting creditors and negotiating a settlement the same way that a third-party would. However, you likely don’t have the experience or expertise that credible debt settlement companies would have.


Handling debt settlement on your own can allow you to do things your way and avoid some of the disadvantages of these programs.

What are Debt Settlement Programs or Services?

In working with a debt settlement service, you’ll typically be advised to start putting money aside in a separate account, like an escrow account. This account is meant to accumulate over a period of time until you have enough to pay what’s anticipated to be the settlement cost.


Many programs will even recommend halting payment to these creditors while this account is growing. This is done in an effort to make the creditor more willing to negotiate and accept a lower debt settlement as well as allow for you to grow the settlement account more quickly.


There are obvious tradeoffs to this process of course, as missing payments to your debts is typically not great financial advice.

Debt Settlement Pros and Cons

Debt settlement programs aren’t for everyone. If you can avoid excessive debt and never even need to consider a debt settlement service, that’s the route we recommend.


However, if you find yourself in a tough spot with unmanageable debt, these programs can be a good way to get your finances back on track. Here are some of the advantages and disadvantages from entering a debt settlement program to keep in mind.

Pay less in your overall debtAvoiding making payments to your creditors can damage your credit
Streamline removing sources of debt entirely, one by oneFees that vary significantly, depending on the company and your debt
Avoid bankruptcyGiving a debt settlement company control over your money
Reduce calls from debt collectorsYou may still have to pay taxes on the full amount of your debt
Opportunity cost of letting your money sit in an escrow-like account

The Process of Debt Settlement

At a high level, here are the steps of a common debt settlement case.

  1. Meet with a debt counselor to understand your debts and financial situation.
  2. Make a plan and start setting aside money in a dedicated account.
  3. Stop all payments to creditors within your settlement plan.
  4. The debt settlement company negotiates with your creditors while you save up.
  5. When a settlement negotiation is reached, use money from your account to pay the debt in a lump sum.

Debt Settlement Letters & Negotiation

Debt settlement letters are what either you or your debt settlement company would use to make an offer to one of your creditors to “settle” your debt. These letters would be sent directly to your creditor once you’ve saved up enough to make an offer. 


The letter should include at least:

  • Your account information (so they can identify you)
  • An explanation of your situation that prevents you from repaying the debt in full
  • An amount of your offer to settle the debt in a lump sum
  • A time frame of repayment
  • Terms of your agreement (such as reporting to credit bureaus and stopping further action to collect debt)

Debt Settlement Sample Letter

+Debt Settlement Letter Template

Settling Credit Card Debt or Loan Debt

If the debt you are trying to make a settlement offer for is from a credit card or most loans, the above process will be used. You would need to contact the credit card company or lender directly providing a letter offering a settlement with all of the required information, communicate and negotiate with the creditor, and then pay the settlement. 


Keep in mind that creditors are not obligated to accept your settlement offers. They may refuse your offer for debt settlement, which means you can either try again or revisit your finances to figure out the best way to repay the debt in full.

Settling IRS Tax Debt

If you’re aiming to settle tax debt, the process is similar but slightly different. Rather than a custom debt settlement letter, you’ll need to apply for an Offer in Compromise. An Offer in Compromise is an IRS tax relief program that allows citizens to apply to settle their tax debt for less than the total amount overdue.


There is typically a significant amount of paperwork required for settling IRS tax debt. Generally, the IRS will push for payment plans or other means of easing repayment in full before accepting any settlement offers. 


According to the IRS, consideration factors for Offer in Compromise settlements include:

  1. Your ability to pay
  2. Your income
  3. Your expenses
  4. Equity of your assets


Requirements for submitting your offer will include:

  1. Form 433-A for individuals or Form 433-B for businesses
  2. Form 656(s) 
  3. $205 non-refundable application fee
  4. Non-refundable initial settlement payment
  5. All required documents specified within the above forms.


You may have the option to choose between a lump sum or periodic payments to settle your debt. [1]


More details on IRS.gov → 

Debt Settlement Lawyers vs. Debt Settlement Companies

In some cases, you may hear of hiring an attorney rather than a debt settlement company. While lawyers are usually far more expensive than a third-party company, the advantage is that they can protect you if you are sued by a creditor.


There are, of course, pros and cons of each side. A lawyer would be more open to explore all debt relief options, whereas debt settlement companies will be focused on just that. On the other hand, lawyers may want to explore more options and end up costing you far more. 


Ultimately, the best route whether you have a lawyer or not, is to do your research up front and be prepared with a vision and what you believe to be the best remedy for your debt situation.

Is Debt Settlement Worth It?

As we’ve said before, if you can be proactive from the beginning and avoid debt settlement entirely, that’s the best route. But if you find yourself in debt and considering settlement, it could be worth it to negotiate with your creditors. 


Depending on the amount and type of debt you’re in, try to negotiate with your creditors on your own before hiring a service or debt settlement attorney. 


If you have done sufficient research and know how you want to proceed to alleviate your debt, hiring a debt settlement company or lawyer can be beneficial in some cases. However, in general, the cons outweigh the pros and you may end up spending more money than simply repaying your debts.

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