Debt settlement: what to check before you sign up

Updated November 9, 2026

Debt settlement means getting a creditor to accept less than the full balance to close a debt. You can negotiate yourself or pay a company to do it. Either way, it usually works only once an account is several months behind, when the creditor or a collector would rather take part of the money than keep chasing all of it.

How a settlement program works

A settlement company usually has you stop paying the enrolled debts and put a monthly amount into a dedicated savings account instead. When enough builds up, it offers a lump sum to one creditor at a time. Programs often run three to four years, and no creditor has to accept an offer.

Federal law protects you when you sign up by phone. Under the Federal Trade Commission's Telemarketing Sales Rule, a company can't charge its fee until it has settled or changed the terms of at least one of your debts, you've agreed to that deal, and you've made at least one payment under it. The savings account must be in your name at an insured bank, and you can take your money out and quit at any time.

Fees are often 15% to 25% of the debt you enroll, or a share of what the company saves you. Ask for the total fee in dollars before you sign.

Your state's rules on settlement companies

States treat settlement companies very differently:

Some ban most of them. North Carolina's debt adjusting law makes it a crime for most companies to charge you to settle or adjust your debts, with an exception for accredited nonprofit credit counselors.
Many require a license or registration. Montana, New Hampshire, Oregon and Pennsylvania are among the states where a settlement company needs a state license or registration before it can sign you up.
Some also cap fees or require specific contract terms.

Check your state page and the state office it lists before you sign anything.

Lawsuits and garnishment while you save

While you're saving, the creditors you stopped paying can add late fees and interest, send the debts to collection, and sue. If a creditor wins in court, what it can take depends on your state:

In most states, up to 25% of your take-home pay, and less in states that protect more.
In North Carolina, Pennsylvania, South Carolina and Texas, wages generally can't be garnished for credit card or medical debt, though a bank account may still be at risk.
Your settlement savings account is a bank account in your name, so a creditor with a judgment may be able to take money from it.

If you're sued, answer by the deadline in the court papers, even if a settlement company says it's handling the debt. Missing it usually means losing by default.

Taxes on forgiven debt

If a creditor forgives $600 or more, it usually sends you and the IRS a Form 1099-C, and the forgiven amount can count as income. You may not owe tax on it if you were insolvent, meaning your debts added up to more than everything you owned, right before the debt was forgiven. You claim that on IRS Form 982.

Settling a debt yourself

You can make the same offers a company would, without the fee:

Check whether the debt is past your state's time limit for lawsuits. In many states a payment, or even a written promise to pay, can restart that clock, so get advice before you offer anything on a very old debt.
Offer a lump sum you can actually pay. Collectors that bought a debt cheaply often take much less than the balance.
Get the agreement in writing before you pay, including that the payment settles the debt in full and how the account will be reported to the credit bureaus.
Pay in a way you can trace, and keep the letter and your proof of payment.

The trade-offs

The missed payments do serious damage to your credit, and the late accounts stay on your credit reports for seven years from when you first fell behind.
Settlement programs handle only unsecured debts such as credit cards, medical bills and some personal loans, and not every creditor will settle.
If you could repay in full over a few years, a debt management plan usually costs less and does less damage to your credit.