# Debt Settlement Pros and Cons: Costs, Credit and Taxes

URL: https://debtcheckusa.com/credit-card-debt/debt-settlement-pros-and-cons
Updated: 2026-09-15
Review: Reviewed by Netanel Baruch, NFCC-certified credit counselor

Debt settlement can close large card debt for less than you owe, but it hurts credit, adds fees and can bring taxes and lawsuits. Here is what to weigh.

Debt settlement pros and cons come down to one trade. A settlement can close a large unsecured debt for less than the balance. Getting there usually costs you missed payments, credit damage and company fees, and it can bring lawsuits and a tax bill on the forgiven amount. It can make sense when repaying in full isn't realistic, but it belongs after the cheaper options in [how to get out of credit card debt](https://debtcheckusa.com/credit-card-debt/how-to-get-out-of-credit-card-debt), not before them.

- Settlement companies usually have you stop paying your creditors and save money in a separate account while they negotiate. Creditors don't have to agree.
- Under the FTC's Telemarketing Sales Rule, a covered debt relief company can't charge its fee until it has settled at least one debt and you've made a payment under that deal.
- The downsides are real: a damaged credit report, late fees and interest that keep adding up, collection calls and the chance of being sued.
- Canceled debt is generally taxable income. If you were insolvent just before the cancellation, some or all of it can be excluded using IRS Form 982.
- With this site's default assumptions, $20,000 of debt shows about $2,240 to $4,580 saved after fees and tax if every debt settles. That's an illustration, not a prediction.

## How debt settlement programs work

According to the FTC, [for-profit companies typically offer debt settlement programs to people with significant credit card debt](https://consumer.ftc.gov/articles/how-get-out-debt). The CFPB describes these companies as ones that [often claim they can negotiate with your creditors to reduce the amount you owe](https://www.consumerfinance.gov/ask-cfpb/what-is-a-debt-relief-program-and-how-do-i-know-if-i-should-use-one-en-1457/).

A typical program runs like this:

1. You enroll unsecured debts, such as credit cards.
2. You stop paying those creditors. The CFPB says settlement companies typically encourage you to stop paying your credit card bills.
3. Every month you put a set amount into a dedicated account until there's enough to pay a settlement.
4. The company makes an offer. If a creditor accepts, money from your account pays that creditor, and the company can then take its fee.
5. This repeats debt by debt until everything enrolled is settled or you leave the program.

Most of the risk sits in step 2. In the months between your last payment and a settlement, fees and interest pile up, and collection calls or a lawsuit can come.

## What the FTC's rule requires of settlement companies

The [FTC's Telemarketing Sales Rule](https://www.ftc.gov/business-guidance/resources/debt-relief-services-telemarketing-sales-rule-guide-business) covers debt relief companies that sell by phone, and that includes calls you make in response to their ads. Three of its rules do most of the work.

### No fee until a debt is settled

The FTC says a company can collect a fee only after three things have happened. It has renegotiated, settled, reduced or otherwise changed the terms of at least one of your debts. There is an agreement between you and the creditor. And you've made at least one payment to the creditor under that agreement. The regulation itself is at [16 CFR 310.4](https://www.law.cornell.edu/cfr/text/16/310.4).

The fee also has to track results. The company can charge a slice of its total fee in proportion to the debt that was settled, or a percentage of what it saved you. If it uses a percentage, that percentage has to be the same for each of your debts.

### Rules for the dedicated account

A company can require you to save in a dedicated account only if all of these are true:

- The account is at an insured financial institution.
- You own the money, including any interest, and you can withdraw it at any time.
- The company running the account isn't owned or controlled by the settlement company or affiliated with it, and it doesn't pay or accept money for referrals.
- You can quit the program at any time without penalty. If you do, the money in the account comes back to you within seven business days, minus any fees the company already earned.

### Disclosures before you sign up

Before you enroll, the company has to tell you how long results will take, what it charges, and how much you must save for each debt before it makes an offer. [16 CFR 310.3](https://www.law.cornell.edu/cfr/text/16/310.3) adds more disclosures to the extent the program relies on, or results in, you not paying your creditors on time, which is how settlement programs usually work: that the service will likely hurt your creditworthiness, that it may lead to collections or lawsuits, and that it may increase what you owe as fees and interest build. If it uses a dedicated account, it has to say the money is yours and you can leave at any time without penalty.

## The cons of debt settlement

### Your credit takes a hit

The FTC is blunt: [your credit report and credit score are likely to be damaged](https://consumer.ftc.gov/articles/how-get-out-debt). The CFPB says settlement can have a negative impact on your credit scores and on your ability to get credit in the future.

### Creditors don't have to settle, and they can sue

The FTC says [your creditors have no obligation to agree to negotiate a settlement](https://consumer.ftc.gov/articles/how-get-out-debt) of what you owe. The CFPB notes that [many lenders do not negotiate with debt settlement companies](https://www.consumerfinance.gov/ask-cfpb/what-is-the-difference-between-credit-counseling-and-debt-settlement-debt-consolidation-or-credit-repair-en-1449/). While you're saving, you may still get calls from debt collectors, and the FTC warns you could even be sued while you're waiting for a settlement.

### What you owe keeps growing

When you stop paying, the CFPB says [you will usually incur late fees, penalty interest and other charges](https://www.consumerfinance.gov/ask-cfpb/what-is-a-debt-relief-program-and-how-do-i-know-if-i-should-use-one-en-1457/). Those charges keep adding to the balance for as long as a debt waits its turn. The CFPB says debt settlement may well leave you deeper in debt than you were when you started.

Leaving partway through can be the worst of both. You could have paid fees on the debts that settled, still owe bigger balances on the ones that didn't, and carry the credit damage either way.

### Forgiven debt can be taxed

The IRS says that [if your debt is canceled, forgiven, or discharged for less than the amount owed, the amount of the canceled debt is taxable](https://www.irs.gov/taxtopics/tc431) in general. The creditor may send a Form 1099-C showing how much was canceled and when. According to [IRS Publication 4681](https://www.irs.gov/publications/p4681), canceled debt still has to be reported as income even if no 1099-C arrives, unless an exception or exclusion applies.

One exclusion is insolvency. The IRS counts you as insolvent to the extent your total liabilities were more than the fair market value of all your assets immediately before the cancellation, and canceled debt is left out of income up to that amount. Say your debts total $30,000 and your assets are worth $22,000 right before a debt is canceled. You're insolvent by $8,000, so up to $8,000 of forgiven debt could be excluded. The exclusion is claimed on [Form 982](https://www.irs.gov/forms-pubs/about-form-982), attached to the federal return, and it comes with a required reduction of certain tax attributes. A tax professional can check the numbers before a settlement closes.

### Fees eat into the savings

The CFPB says debt settlement companies often charge expensive fees. Fees differ from company to company, so compare the fee each one discloses. The CFPB also says settlement companies usually can't get better terms than you could get by negotiating with your lenders and debt collectors yourself.

## The pros of debt settlement

The case for settlement is narrow, but it's real:

- If a creditor agrees, you pay less than the full balance and that debt is resolved. For someone with large unsecured debt they can't repay in full, that can be a path forward.
- Under the FTC rule, a covered company isn't paid until a debt is actually settled and you've made a payment under the deal.
- Money in the dedicated account stays yours, and you can leave without a penalty.

All of that depends on creditors saying yes and on you keeping up the deposits.

## What debt settlement costs: an illustrative example

The cost depends on what creditors accept, what the company charges, how long it takes and your taxes. We don't quote typical settlement percentages or fees because we haven't found a primary source that publishes them. The estimator's defaults below are adjustable assumptions, not quotes or market data, so swap in what a company actually discloses to you.

| Assumption | Default in the estimator |
| --- | --- |
| Share of the balance paid to creditors | 45% to 60% |
| Company fee | 20% of the enrolled debt |
| Program length | 36 months |
| Tax rate on forgiven debt | 22% |

Here is what those defaults give for $20,000 of enrolled debt, with no insolvency exclusion.

| Illustrative only | Low settlement (45%) | High settlement (60%) |
| --- | --- | --- |
| Paid to creditors | $9,000 | $12,000 |
| Company fee | $4,000 | $4,000 |
| Total you pay | $13,000 | $16,000 |
| Debt forgiven | $11,000 | $8,000 |
| Estimated tax on forgiven debt | $2,420 | $1,760 |
| Savings after fees and tax | $4,580 | $2,240 |
| Monthly deposit over 36 months | about $361 | about $444 |

Read the table as a best case. It assumes every debt settles at its starting balance, and it leaves out late fees and interest added while you're not paying, the cost of a lawsuit, and debts that never settle. A fee based on the amount saved, which the FTC rule allows, would change the math, and insolvency could shrink the tax line.

Tool: [Settlement estimator](https://debtcheckusa.com/credit-card-debt/tools/settlement-estimator). What a settlement program might cost after fees and taxes.

## How to check a debt settlement company

- Check the company with your state attorney general and your local consumer protection agency, as the [FTC recommends](https://consumer.ftc.gov/articles/how-get-out-debt). A clean record doesn't prove a company is legitimate.
- The FTC also says to ask whether debt relief companies must be [licensed to work in your state](https://consumer.ftc.gov/articles/how-get-out-debt), and if they are, whether the ones you're considering are licensed.
- Search the company's name in the [CFPB Consumer Complaint Database](https://www.consumerfinance.gov/data-research/consumer-complaints/). The CFPB cautions that the database isn't a statistical sample, and a low number of complaints doesn't necessarily mean little or no harm.
- Get the required disclosures in writing and check them against the rule's list above.

**Red flags that point to a scam**

The FTC says only scammers will ask you to pay them before they settle any of your debts. Be wary of any company that says results are guaranteed or that it will settle all your debts. The FTC's [debt guide](https://consumer.ftc.gov/articles/how-get-out-debt) also warns about anyone who tells you to stop talking to your creditors without explaining the consequences, or who promises results from a government debt relief program. The FTC also says [an unexpected call or text offering to settle your debts fast](https://consumer.ftc.gov/consumer-alerts/2026/03/looking-debt-relief-heres-how-avoid-scam) and asking for personal or financial information is a sure sign of a scam. You can report a debt relief scam to the FTC at ReportFraud.ftc.gov.

## Alternatives, from gentlest to most drastic

If you're weighing settlement against a new loan, [debt consolidation vs debt settlement](https://debtcheckusa.com/credit-card-debt/debt-consolidation-vs-debt-settlement) compares the two side by side.

### Pay it off yourself

If your balances go down at the budget you have, a payoff plan in [avalanche or snowball order](https://debtcheckusa.com/credit-card-debt/debt-avalanche-vs-snowball) has no company fees and you don't have to stop paying anyone. You can also call creditors and ask for a lower payment or a settlement yourself; our guide on [how to negotiate credit card debt](https://debtcheckusa.com/credit-card-debt/how-to-negotiate-credit-card-debt) walks through the steps. If you reach a deal, the CFPB says to [get the plan and the collector's promises in writing before you make a payment](https://www.consumerfinance.gov/ask-cfpb/how-do-i-negotiate-a-settlement-with-a-debt-collector-en-1447/).

**Pay it off yourself with a plan.** Good when: Your balances go down at the budget you have. Watch out: It needs a steady monthly budget, and nobody negotiates for you.

### Nonprofit credit counseling

The CFPB says [credit counseling organizations are usually non-profit organizations](https://www.consumerfinance.gov/ask-cfpb/what-is-credit-counseling-en-1451/). With a debt management plan, you make one payment to the counseling organization and it pays your creditors. The plan typically lowers your monthly payments along with interest charges and fees. Counselors may charge fees for some services. The FTC says a plan can take 48 months or more, and you might have to agree not to apply for or use more credit until it's done.

**Nonprofit credit counseling.** Good when: Card rates are high and one lower payment would get you there. Watch out: You may have to stop using or applying for credit, and a plan can take 48 months or more. Ask about fees first.

### Debt settlement

**Debt settlement.** Good when: You have large unsecured debt and are already falling behind. Watch out: It damages your credit, charges fees, forgiven debt can be taxed, and creditors can still sue.

### Bankruptcy

The FTC says [bankruptcy is generally considered a last option](https://consumer.ftc.gov/articles/how-get-out-debt) because of its long-term negative impact on your credit. A bankruptcy attorney can explain how the law applies to your debts. The pillar guide on [how to get out of credit card debt](https://debtcheckusa.com/credit-card-debt/how-to-get-out-of-credit-card-debt) explains how bankruptcy works and where it fits.

## Bottom line

Debt settlement can resolve large unsecured debt for less than you owe when repaying in full isn't realistic. You pay for that with credit damage, fees and possibly taxes, and creditors can refuse or sue along the way. Run your own numbers with the [settlement estimator](https://debtcheckusa.com/credit-card-debt/tools/settlement-estimator), check any company with your state, and talk to a nonprofit counselor before you stop paying anyone.

Start the Debt Check: https://debtcheckusa.com/debt-check

## Common questions

### Does debt settlement hurt your credit?

Yes. The FTC says your credit report and credit score are likely to be damaged. Where a program relies on you not paying your creditors on time, which is how settlement programs usually work, federal rules require the company to tell you before you sign up that the service will likely hurt your creditworthiness.

### Is forgiven debt from a settlement taxable?

Generally, yes. The IRS treats canceled debt as taxable income unless an exception or exclusion applies. One exclusion covers people who were insolvent just before the debt was canceled, and it is claimed on Form 982. A tax professional can tell you how the rules apply to your situation.

### Can a debt settlement company charge fees upfront?

Not under the FTC's Telemarketing Sales Rule. A company covered by the rule can't collect a fee until it has settled or changed at least one of your debts and you've made at least one payment under that agreement.

### Can a creditor sue me while I'm in a settlement program?

Yes. Creditors don't have to agree to a settlement, and the FTC warns you could be sued while you're waiting for one. You may also keep getting calls from debt collectors.

### Can I settle a debt myself without a company?

Yes. The CFPB says settlement companies usually can't get better terms than you could get by negotiating with your lenders and collectors yourself. Get any agreement in writing before you pay.

## Sources

- [FTC: Debt Relief Services and the Telemarketing Sales Rule: A Guide for Business](https://www.ftc.gov/business-guidance/resources/debt-relief-services-telemarketing-sales-rule-guide-business)
- [Cornell LII: 16 CFR 310.4, Abusive telemarketing acts or practices](https://www.law.cornell.edu/cfr/text/16/310.4)
- [Cornell LII: 16 CFR 310.3, Deceptive telemarketing acts or practices](https://www.law.cornell.edu/cfr/text/16/310.3)
- [FTC: How To Get Out of Debt](https://consumer.ftc.gov/articles/how-get-out-debt)
- [FTC: Looking for debt relief? Here's how to avoid a scam](https://consumer.ftc.gov/consumer-alerts/2026/03/looking-debt-relief-heres-how-avoid-scam)
- [CFPB: What is a debt relief program and how do I know if I should use one?](https://www.consumerfinance.gov/ask-cfpb/what-is-a-debt-relief-program-and-how-do-i-know-if-i-should-use-one-en-1457/)
- [CFPB: What is the difference between credit counseling and debt settlement, debt consolidation, or credit repair?](https://www.consumerfinance.gov/ask-cfpb/what-is-the-difference-between-credit-counseling-and-debt-settlement-debt-consolidation-or-credit-repair-en-1449/)
- [CFPB: What is credit counseling?](https://www.consumerfinance.gov/ask-cfpb/what-is-credit-counseling-en-1451/)
- [CFPB: How do I negotiate a settlement with a debt collector?](https://www.consumerfinance.gov/ask-cfpb/how-do-i-negotiate-a-settlement-with-a-debt-collector-en-1447/)
- [CFPB: Consumer Complaint Database](https://www.consumerfinance.gov/data-research/consumer-complaints/)
- [IRS: Topic no. 431, Canceled debt: Is it taxable or not?](https://www.irs.gov/taxtopics/tc431)
- [IRS: Publication 4681, Canceled Debts, Foreclosures, Repossessions, and Abandonments](https://www.irs.gov/publications/p4681)
- [IRS: About Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness](https://www.irs.gov/forms-pubs/about-form-982)