What to Expect with Debt Settlement
When you’re overwhelmed by debt, every option can feel uncertain. Debt settlement is often one of the most misunderstood, but if you’ve fallen behind on payments and can’t afford to catch up, settlement can be a lifeline. It’s not without its challenges, though.
Before you decide if settlement is right for you, it’s important to get answers to important questions like:
- How does debt settlement work?
- How long does it take?
- What are the long-term debt settlement tax and credit implications?
What is debt settlement?
Debt settlement, sometimes called debt resolution, is the process of negotiating with creditors or collection agencies to repay less than the total amount you owe.
Here’s how it typically works:
- You stop making payments on a debt. Often you've already missed payments because you can't afford them, but in some cases you may decide to intentionally withhold payments in order to begin the settlement process.
- The original creditor “charges off” the account, writing it off as a loss and often selling it to a third-party collection agency for quite a bit less than the original debt amount. Keep in mind that a creditor writing off a debt does not remove your legal obligation to the debt. You still technically owe the full debt amount.
- That agency then tries to collect what they can. You negotiate to pay a portion––say, $5,000 on a $10,000 debt––and once you’ve made your agreed-upon payments, the rest is forgiven.
Unlike a debt management plan (DMP), where you repay your balances in full with lower interest rates, or bankruptcy, where you might liquidate assets to discharge debts, debt settlement focuses on partial repayment of already charged-off accounts.
Common fears about debt settlement
While there can be a ton of benefits to negotiating a settlement on your debts, many consumers hesitate to pursue that option. They're often afraid of scams, of lawsuits, or of damaging their credit beyond repair. And while those fears are understandable, the debt settlement landscape has changed dramatically in recent years.
In the past, for-profit settlement companies were sometimes guilty of taken advantage of struggling consumers by charging steep fees upfront and delivering little in return. Fortunately, legitimate nonprofit organizations like MMI are now entering the debt settlement space. At MMI, our debt resolution plan (DRP) fees about 50% less than traditional, for-profit settlement companies and we only collect those fees once each account is successfully settled.
Still, debt settlement requires patience and trust. You’ll spend the early months saving funds for your first settlement offer, which means you won’t see immediate progress. And during that time, collection calls and letters will continue. You may even be threatened with a lawsuit. Luckily, being potentially sued by a creditor isn't nearly as scary as it seems, and at MMI we offer option legal support throughout your DRP to handle those issues on your behalf.
If collectors won’t stop contacting you, you have the right to send a “stop contact” letter to halt calls and letters while you work on your plan. Learn more about your rights when dealing with a debt collector.
Will debt creditors work with me?
Many creditors and collection agencies are open to working with consumers who are sincere about resolving debt. Once a debt is charged off, the collector’s goal is to recover as much as possible (as quickly as possible), meaning they’re often willing to accept a debt settlement offer if it’s reasonable and paid quickly.
Working with a trusted nonprofit like MMI gives you the leverage and experience you need to make that negotiation successful. MMI’s counselors have relationships with major creditors and understand what kinds of offers are likely to be accepted.
How long does debt settlement take?
Debt settlement typically takes between 24 and 48 months, though the timeline depends on your total debt, your ability to save toward settlements, and your creditors’ willingness to negotiate.
You’ll start by saving money into a designated account until you have enough to make your first settlement offer. Once a creditor accepts, you’ll make the agreed-upon payment (sometimes in installments).
At MMI, clients receive guidance throughout their debt resolution plan, from building the savings fund to negotiating and finalizing settlements, making the process more predictable and transparent than working alone.
Can I still use my credit card after debt settlement?
Once you enter debt settlement, the credit card accounts that you settle will be closed, and you’ll lose access to those lines of credit. That’s because accounts need to be charged off and closed before you can negotiate a settlement.
After your accounts are settled and your finances stabilize, you can begin rebuilding credit with tools like secured credit cards or small personal loans. Responsible use over time will show positive activity on your credit report and gradually offset the damage from past delinquencies.
How long does it take to improve my credit score after debt settlement?
Debt settlement will lower your credit score in the short term, often significantly, because it involves missed payments and charged-off accounts. However, your credit won’t stay damaged forever.
In most cases, you’ll start to see gradual improvement within 12 to 24 months after your final settlement, especially if you’re managing new accounts responsibly and keeping balances low. By three to five years after their settlement, many consumers find their credit score has recovered enough to qualify for new loans or credit cards––and sometimes it’s even stronger than before if they’ve stayed debt-free.
If your goal is faster credit recovery, a debt management plan may be a better fit, since DMPs involve full repayment and often lead to a healthier credit score by the end of the program.
Does debt settlement affect how I file my taxes?
One often-overlooked consequence of debt settlement is its impact at tax time. When a creditor forgives a portion of your debt, generally more than $600, they must send you a 1099-C form reporting the forgiven amount as taxable income.
You’ll need to include that amount in the “Other Income” section of your tax return. This could increase your tax bill or even push you into a higher bracket. While this doesn’t mean debt settlement isn’t worth it, it’s important to plan ahead for any debt settlement tax consequences that may arise.
For more details, read our guide, What is Debt Forgiveness and What Does It Cost?
When does debt settlement make sense?
Debt settlement isn’t for everyone, but it can be a smart option when:
- You’re already behind or about to fall behind on payments
- You can’t afford a DMP or Chapter 13 bankruptcy plan
- Your credit score isn’t your top priority right now
- You want or need to resolve debt for less than what you owe
Like bankruptcy, consolidation loans, and debt management plans, debt settlement/debt resolution is a legitimate option for dealing with your debt. Determining which is right for you all comes down to the specifics of your situation and your goals.
The nonprofit difference: MMI’s debt resolution plan
If debt settlement feels like the right move, consider working with a nonprofit organization like MMI. Our DRP offers the same benefits as traditional settlement, but with lower fees, built-in support, and your best interests at the center of every step.
If you’re struggling with unmanageable debt, reach out today for free, confidential counseling to learn whether debt resolution is right for you. There’s always a way forward, and MMI can help you find it. Get in touch today.
