How to Negotiate a Debt Settlement

The following is presented for informational purposes only and is not intended as credit repair or legal advice.

If you feel like you’re drowning in debt, the idea of settling for less money than you owe can be appealing. You could hire a debt settlement company that will work on your behalf to negotiate settlements with your creditors. That can be a worthwhile option if you'd rather let someone else handle the nitty-gritty of negotiating a settlement.

But if you prefer to handle things on your own, you can always just negotiate a settlement plan with your creditors all on your own.

Why do creditors accept settlement offers?

With a secured loan, like a mortgage or auto loan, the lender may have a right to claim the collateral (e.g., the home or car) and won’t be as willing to settle. But there’s no collateral with unsecured loans, credit card debt, personal loans, and medical bills. Creditors can either send your accounts to collections, sue you for nonpayment, or sell the debt to a third-party debt buyer or collector.

Sending an account to collections isn’t free, as the company will have to pay operational costs for in-house collections or a fee to third-party collectors. Hiring attorneys to sue you for unpaid debts costs money as well. Even if the creditor can sell the right to collect the debt, it often won’t recover the full amount you owe.

According to a Federal Trade Commission report on the debt buying industry from 2013, debt buyers paid an average of 4.0 cents per dollar of uncollected debt. The figure may include debts that have been sold and resold multiple times, which can lower their value. Still, as a borrower, you may see why you have some negotiating power.

If you offer your original creditor more than it could potentially make from a debt buyer, it may accept your offer even if it’s for much less than the full amount owed. Similarly, if you offer a debt collector more than it paid for your debt, it may be making money even if you don’t repay the debt in full.

How to create a DIY debt settlement plan

While many creditors might agree to settle your debt for less than what you owe, there’s no guarantee that debt settlement will work. If you’re considering trying it on your own, here’s a rough guide to the steps you may want to take:

1. Assess your situation

Create a list of your past-due accounts with the creditors’ names, how much you owe, and how far behind you are on payments. You’ll need this list as the basis for your plan and to decide which accounts to tackle first.

If you think you can afford to make minimum payments or might be able to stay current on your accounts with a hardship payment plan, that might be a better option. While debt settlement can save you money, it isn’t guaranteed to work and may hurt your credit and lead to additional fees in the meantime.

2. Research your creditors

Creditors may have different policies for when they’ll accept a settlement offer and how much (or little) they’ll accept.

For example, you may need to be at least 90 days late on an account before a creditor considers settling. Or, some creditors might not settle at all, and you’ll have to wait until the debt is sold to another company.

Some creditors might also be more likely to sue you to collect an unpaid debt than others. Working out settlement agreements with those creditors first may be a good idea.

You can research online to learn about others’ experiences and inform your offer, keeping in mind that other people’s outcomes might not reflect a company’s current practices.

3. Start a settlement fund

Although you won’t have to repay the full amount, you still have to pay something if you want to settle an account. You may be able to pay that amount over several monthly payments, though you may be able to negotiate a lower total payment if you can pay more upfront.

You might want to open a new bank account for your settlement fund, so you aren’t tempted to spend the money elsewhere and to prevent accidental overdraws during the settlement process. Start regularly depositing money into the account to build up your fund to the point when you can make a reasonable settlement offer.

It could be a good idea to store your settlement fund in an account that isn’t run by a creditor that you’re also negotiating with to keep the company from getting an insight into your financial position.

4. Make a debt settlement offer to the creditor

Once you think you have enough money saved up to settle an account, you can call your creditor and make an offer. In some cases, the creditor may have already sent you a settlement offer. You could accept the offer, or respond with a counteroffer.

Whether you’ve lost your job or are dealing with medical bills, share why you can only afford the settlement amount you’re offering. To avoid confusion, make sure the offer is for a specific dollar amount rather than a percentage of your balance.

If the creditor doesn't agree to settle, you may want to wait until it sells the debt and try again with the debt buyer or collection agency.

5. Review a written debt settlement agreement

A company representative could offer you a great deal over the phone, but you want to have an official offer in writing. The proposal should have your name, the creditor or debt collector’s name, and the account number. It should also have the terms of the settlement, such as the amount being paid, whether it’s paid in a lump sum or over time, and the payment due dates.

Make sure the letter clearly states that your payment will satisfy your obligation. It may say the account will be settled, paid in full, accepted as settlement in full, or something similar. Keep a copy of the letter, and any payment confirmations, in case a collection company contacts you about the debt again in the future.

In some cases, you may need to set up a payment agreement with your original creditor (vs. a debt buyer) before it sends you the settlement letter. Try to work out an arrangement to schedule your payment in the future, giving the company several business days to get the letter to you in the meantime. You could then cancel the payment if you don’t receive a letter.

6. Pay the agreed-upon settlement amount

Once you’ve come to an agreement and have reviewed a written offer, pay the settlement amount, and you won’t be responsible for the debt any longer. Then it’s time to move on to the next account.

Why settling might be your best option

Once an account is so far past due that it's been charged off by the original creditor, the bulk of the damage has already been done. Settlement, particularly in this instance, is often the best way to put an old debt behind you and wipe the slate clean so you can start rebuilding your credit and your finances. 

If your accounts are in better shape and you can afford another option, like a debt consolidation loan or a debt management plan, those may be better (especially if you're interested in preserving your credit score). But for many people considering settlement, those other options just aren't on the table for one reason or another.

Why debt settlement might not work

Settlement can save you a lot of money, but it's not a guarantee and it's not a quick fix.

• Your credit can take hit. Whether you choose a DIY route or work with a debt settlement company, the process could hurt your credit. That said, most people considering settlement already have a damaged credit history, so this may not be a concern.
• You may not be delinquent enough. Creditors generally don’t agree to settle an account if you’re only a few days late. You may need to be at least 90 or more days behind on your payments before a credit card company will even consider a settlement. In other words, if you're no already severely delinquent, but you want to negotiate a settlement, you'll likely need to stop making payments, which will absolutely crush your credit score (again, that may not be a concern for many).     
• You may be sued. Maybe the most stressful part of the settlement process is that some creditors may take legal action against you. It's not the end of the world and you'll have options to deal with it, but it's a very real possibility you'll need to consider.

Debt settlement is a major step to take, but depending on your circumstances it may be the one that makes the most sense for you. If you're unsure how to deal with out of control debt, MMI offers free financial counseling 24/7, online and over the phone.