Debt Settlement Usually a Bad Alternative to Bankruptcy

Oct 27, 2023 By Susan Kelly

Debt settlement is not as user-friendly as the business would have you believe, and some of those who complimented the firms didn't fully comprehend their choices or the long-term effects of debt settlement.

If you're battling with past-due debt, you might be wondering whether debt settlement is a bad idea. Depending on how you go about it—using a third-party debt settlement business or paying the debt on your own—it might be a viable alternative.

But you may wonder, Is debt settlement bad? Debt settlement isn't the lawless frontier it once was. When customers commonly paid hefty upfront fees to businesses that offered no assistance.

On the other hand, if calamity is near, you should make the wisest decision possible. Knowing which solution is best for you is the first step. That starts right now.

Debt settlement: What is it?

Debt settlement is the method of paying off past-due debt by guaranteeing the creditor a sizeable lump-sum payment while still receiving a significant discount from what you owe.

Based on your specific circumstances, debt settlement offers could vary from 10% to 50% of what you owe. After then, the creditor must figure out whether to accept any proposals.

Even though debt settlement can take longer than bankruptcy, it still hurts your credit. Bankruptcy may be your best (or only) option if you require emergency assistance or cannot make monthly payments.

Why is debt settlement not a wise decision?

1. Your creditors may not negotiate your debt.

You may need to be more capable of reaching an arrangement with the debt settlement business you're paying. Every creditor can settle a debt at their discretion, and some creditors flatly decline to work with debt settlement firms.

2. Impact of Debt Settlement on Taxes

You can still be liable for taxes on the decreased amount if a creditor decides to dismiss your debt in return for a smaller payment. The creditor must inform the IRS if the agreement resulted in a debt relief of $600 or more.

For instance, if a creditor demands $10,000 in repayment but accepts a one-time transaction of $7,500, you must take the difference of $2,500 into your taxable income.

3. You can accumulate additional debt

Companies specializing in debt settlement advise their clients to suspend payments while they bargain with creditors. That negotiation can take a while because it takes a lot of work.

You run the danger of accruing late fees and interest if you cease making payments on a debt. Furthermore, it does not necessarily follow that you are no longer liable for a particular obligation just because a creditor agrees to lower the amount you owe. For federal tax reasons, your forgiven debt may be viewed as taxable income.

Consequences of debt settlement

1. Issues in Negotiation

It's a harsh reality, but the creditor can reject the settlement proposal. Consequently, you and the debt settlement business might need to send a counteroffer. You might also be compelled to contact the original creditor to see if you can arrange a payment schedule.

In the worst situation, you might owe more than you did initially, and a refused proposed settlement might drive you toward bankruptcy.

2. Adverse effects on credit scores

Your credit score may suffer after a debt settlement, possibly by more than 100 points, and the harm may take some time to heal. It takes at least 7 years for a debt settlement to be removed from your credit report.

3. Greater Debt

Your debt can increase by hundreds or even thousands of dollars, and it is due to costs paid to a debt settlement firm or interest and fees assessed by an original creditor.

Alternatives to Debt Settlement

1. Demanding a balance transfer credit card

You might be able to transfer your debt to a credit card with a 0% promotional APR by making a balance transfer. If you pay off the loan balance prior to the conclusion of the 0% term, interest will not be charged.

2. Debt Management Plan

A debt management plan is one of the resources available to a nonprofit credit counselor. When you join a debt management framework, your counselor will speak with your lenders to develop a repayment strategy that combines your bills into a single monthly payment.

3. Nonprofit Credit Counseling

You can regain financial stability by speaking with a nonprofit credit counseling organization counselor. A credit counselor can offer budgeting advice and debt consolidation suggestions.

4. Considering a loan for debt consolidation.

Obtaining a consolidation loan has two advantages: First, you'll save money by paying a cheaper interest rate. Second, streamlining your repayments into a single loan payment each month can facilitate budgeting and cash flow management.

Impact of Debt Settlement on Credit Score

If you are authorized for a loan, debt settlement will adversely affect your capacity to receive one, as well as the rate of interest you pay for seven years, and will undoubtedly affect both.

A debt settlement results in a 75–100 point drop because it is an admission that you failed to pay your bills as agreed. The greater your credit score declines, the worse it is.

To settle your debt, you usually need to make a one-time payment. It is typically recommended that you discontinue making minimum payments each month until a final agreement has been reached.


Risks associated with debt settlement through a firm are high. Before entering into a partnership with a debt settlement organization, you must consider all your options, including debt consolidation and nonprofit credit counseling.

Although bankruptcy may be the quickest way to get out of debt, it will negatively affect your credit. You may hamper your ability to secure a loan because bankruptcy will remain on your credit records for 7–10 years.

Right now, neither bankruptcy nor debt settlement is the best option for you. And you might be correct, and you could require a loan to consolidate your debts.

Additionally, a debt consolidation loan helps you pay off your debt by negotiating with your creditors to lower your rate of interest, reduce fees, and establish a workable payment schedule.

Frequently Asked Question

Question 1. Is debt settlement bad?

Answer: Even though debt settlement can take longer than bankruptcy, it still hurts your credit. Bankruptcy may be your best (or only) option if you require emergency assistance or cannot make monthly payments.

Question 2. When is debt settlement appropriate?

Answer: For those capable of covering their debts, neither bankruptcy nor debt settlement is a wise choice. Debt settlement is a good option if your debt is excessive and you can't or don't want to file for Chapter 7 bankruptcy.

Question 3. What Amount is Considered a Settled debt?

Answer: A creditor typically accepts repayment of about 50% of the entire debt owing. The creditor agrees to settle your debt because it is preferable to get a portion of the money owed than not get anything at all.

Question 4. Which option—bankruptcy or debt settlement—is preferable?

Answer: Even though filing for bankruptcy frees you from creditors, the problems could persist for years. Debt settlement causes less harm to your fico score and is reported for seven years.

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