*Please note that while we may promote certain credit card products through affiliate links on our YouTube and social media channels, currently, no credit card affiliate links are present on this website. If you click on a link and make a purchase on our YouTube videos or social media channels, we may receive a commission, as clearly disclosed in the video description.
*This article is updated regularly. While we try to maintain and update content on a consistent basis, offers with credit card issuers change often. Perks, benefits, fees, and offers for credit cards may vary from the content included in this post. The content on this page is accurate as of the posting date; however, some of the offers mentioned may have expired.
If you’re struggling with debt, you might be tempted to consider debt settlement through a debt relief program as a quick solution to reduce what you owe and regain financial control. Debt settlement programs promise relief by negotiating with your creditors to settle your debt for less than the full amount, making it seem like a fast track to debt management and financial recovery. However, debt settlement is not the silver bullet it appears to be. In fact, it can have severe long-term consequences that may leave you in a worse financial situation than when you started.
In this article, we’ll break down why debt relief programs via debt settlement are not the best strategy for eliminating debt, the significant risks it poses to your overall financial health, and how you can pursue more viable options to manage debt and rebuild your financial position.
Debt settlement is a type of debt relief program where a company negotiates with your creditors to accept a reduced lump-sum payment to settle your debt. Essentially, you stop making payments on your debts while you save up money, and the settlement company uses this leverage to negotiate a lower payoff amount.
While this might sound like a good deal — paying less than what you owe — debt settlement comes with numerous hidden drawbacks that can make it more damaging than helpful in the long run.
Debt relief programs via debt settlement often present themselves as a viable way to reduce debt quickly, but the reality is that they are fraught with risks that can lead to lasting damage to your finances. Here are the most significant downsides to debt settlement:
1. Severe Damage to Your Credit Score
One of the biggest drawbacks of debt settlement is the negative impact it has on your credit score. In order to successfully settle your debts, most programs require you to stop making payments to your creditors for several months, or even longer, while negotiations are underway. During this time, your accounts become delinquent, and late payments are reported to the credit bureaus.
The result? Your credit score will drop — significantly. Late payments, account delinquencies, and debt settlements can remain on your credit report for up to seven years, making it difficult to qualify for new credit, get a mortgage, or even secure favorable interest rates. This can severely limit your financial opportunities, long after the debt is settled. Even worse, if debts are settled through a monthly repayment plan with the creditor, they can continually impact your credit as a negative account the entire time it’s being settled. What’s more, even once the account is settled, you’re still left with the entire delinquent history of the account, which severely impacts your credit even after the debt relief program / debt settlement program is complete.
2. High Fees and Costs
Debt settlement companies don’t work for free. They typically charge a fee for their services, which can range from 15% to 25% of the settled amount. That means even if you save money on your total debt, a significant portion of those savings goes toward paying the debt settlement company.
Additionally, creditors may charge late fees, penalties, and interest on your delinquent accounts while the settlement process drags on, further increasing the amount you owe. In the end, the overall cost of debt settlement can outweigh the benefits of reducing your original debt.
3. Debt Forgiveness and Tax Consequences
If you settle your debts for less than the full amount, the IRS considers the forgiven amount as taxable income. This means that any debt relief you receive from a settlement could result in an unexpected tax bill. For example, if you settle a $10,000 debt for $6,000, the $4,000 difference is considered taxable income, and you may owe taxes on it.
This tax liability can be an unpleasant surprise for many people who thought they were escaping debt only to be hit with a large tax bill.
4. No Guarantee of Success
Debt settlement programs make no guarantees. Creditors are not obligated to settle, and some may refuse to negotiate altogether, especially if they believe they can collect the full amount through legal action or other means. If creditors refuse to settle, you’ll still owe the original debt, plus any accumulated interest and penalties, putting you in a worse position than before.
Moreover, even if some creditors agree to settle, not all of them may be on board. You could end up with some debts settled and others still outstanding, leaving you in a precarious financial situation with a damaged credit score and unresolved debts.
5. Potential for Lawsuits
While you stop making payments during the settlement process, creditors can and often do take legal action to recover the debt. This can result in lawsuits, wage garnishments, or even liens on your property. If your creditor wins a judgment, you could be forced to pay not just the original debt but also court fees and legal costs, further increasing your financial burden.
The immediate relief of settling your debts may come at the expense of your long-term financial health. The damage done to your credit, combined with the high fees and potential for additional costs like taxes and legal fees, means that you may struggle to regain financial stability even after your debts are settled.
Debt settlement programs can trap you in a cycle of financial instability, where your credit is ruined, your options for new credit are limited, and you may still owe money to creditors. For many, the trade-offs simply aren’t worth it.
Instead of opting for debt settlement, consider more sustainable solutions that protect your financial future and help you get out of debt without sacrificing your credit score or long-term financial health. Here are some viable alternatives:
1. Debt Management Plans (DMPs)
A debt management plan (DMP) is a structured program offered by credit counseling agencies to help you repay your debts over time. With a DMP, a credit counselor works with your creditors to negotiate lower interest rates or waive fees, making it easier for you to repay the full amount of your debts without damaging your credit.
DMPs don’t involve stopping payments or settling for less than you owe, which means your credit score won’t suffer the way it would with debt settlement. Over time, you can pay off your debt while preserving your credit health.
2. Credit Repair and Budgeting
For many people, the best way to tackle debt is through a combination of credit repair and smart budgeting. Credit repair helps you address inaccuracies on your credit report, while budgeting helps you allocate your resources to paying down debt effectively. By focusing on reducing your debt over time and maintaining on-time payments, you can improve both your credit score and your financial position.
Start by creating a budget that prioritizes debt repayment. Use the debt snowball or avalanche method to focus on one debt at a time, either paying off the smallest balances first (snowball) or targeting the highest-interest debt (avalanche). This gradual approach to debt reduction may take time, but it won’t come with the long-term consequences of debt settlement.
3. Debt Counseling
Working with a certified debt counselor can help you understand your financial situation, develop a realistic plan to manage your debt, and improve your credit over time. A debt counselor can guide you through budgeting, credit repair, and negotiating with creditors to find solutions that work for your financial goals.
Unlike debt settlement companies, which focus on negotiating lump-sum payments, debt counselors aim to help you pay off your debts while maintaining your credit health and protecting your financial future.
At the end of the day, debt relief programs through debt settlement are a high-risk, long-term solution that comes with severe consequences. The long-lasting damage to your credit, the high fees, the potential for legal action, and the tax consequences make it an unattractive option for most people.
Instead of debt settlement, we recommend exploring alternatives like debt management plans, credit repair, and budgeting to help you manage and reduce your debt without sacrificing your financial future. By taking a more responsible approach, you can work toward a stable financial position that supports your long-term goals.
📷 Photo by Christian Erfurt on Unsplash
Affiliate and Relationship Disclosure: Credit Mileage may receive compensation from affiliate links included in this post at no extra cost to you. This helps support our mission of providing quality financial education and resources. Additionally, Credit Mileage has a direct business relationship with eCreditAdvisor, which may be mentioned or linked in our content. Our opinions and recommendations remain our own, and we only promote products or services that we believe offer value to our readers. We currently do not have any credit card affiliate links on our website.
Editorial note: The views expressed in this article are solely those of the author and do not reflect the opinions of any bank, credit card company, airline, or hotel chain. None of these organizations have reviewed, approved, or endorsed the content in any way.
Legal and Financial Advice Disclosure: Credit Mileage is not a law firm, and this article is not intended to provide legal or financial advice. This information is meant purely for educational purposes. We strive to offer accurate and up-to-date information, but it is not a substitute for professional financial or legal advice. Always consult with a qualified attorney or financial advisor before making any decisions regarding your financial situation.
The Bank of America Travel Rewards credit card offers a straightforward approach to earning travel rewards with unlimited 1.5 points per dollar and no annual fee. Ideal for budget-conscious travelers, this card provides value through flexible redemption and zero foreign transaction fees.
Credit cards offer numerous benefits, including rewards and building credit, that can outweigh their costs if used responsibly. While avoiding them might seem like a way to stay out of debt, it can lead to missed savings and opportunities. This blog explores the hidden costs of not using credit cards and their potential advantages.
Advertising Disclosure
At Credit Mileage, we believe smart credit management is one of the key cornerstones for sound personal finance. Using credit from an educated point of view so that you don’t accumulate debt while swiping to maximize and best utilize the points and rewards programs that different credit cards offer is at the heart of what Credit Mileage aims to educate consumers about.
That’s why we offer a wide array of educational and editorial content and credit card reviews so that you can choose the best card to achieve your goals, depending on which type of points/rewards programs you like.
When you apply for a credit card through our site and are approved, we may receive compensation from our partners, which can influence how and where certain products are featured.
Although we don’t include every credit card on the market, we thoroughly research and evaluate each card we feature. The content we produce is created without any input or oversight from credit card issuers, banks, or partners. For more details, please review our advertising policy and credit card evaluation framework.
