If you’re thinking about debt settlement, it’s normal to feel cautious. The process can affect your credit, increase certain costs, and doesn’t work for every kind of debt.  

At the same time, many people find it’s a smart way to handle debt when other options don’t fit. The key is knowing both the risks and the safer practices to look for so you can decide if it’s the right step for your situation. 

How Debt Settlement Works 

Debt settlement is a process designed to reduce what you owe on certain unsecured debts, such as credit cards or personal loans. Here’s the general idea: 

1. You pause payments on enrolled debts: Instead of sending money to creditors, you set aside funds in a dedicated account you control. 
2. You build savings over time: Once enough money accumulates, it can be used to make settlement offers. 
3. Negotiation takes place: A debt settlement company contacts creditors and may try to reach an agreement for less than the full balance. 
4. You review and approve offers: No settlement is finalized without your consent. 
5. Payments and fees are processed: Funds from your account cover the settlement, and the company collects its fee afterward. 

While each company may handle details differently, two key safeguards to look for are: 

• You keep ownership of the account where your settlement funds are stored. 
• Fees are only charged after a debt is successfully settled. 

The Real Risks to Consider 

Debt settlement can create challenges that you’ll want to weigh carefully before enrolling. Common risks include: 

• Credit impact: Settlement usually requires stopping payments on enrolled debts. Missed payments are typically reported to credit bureaus and may lower your credit score. 
• Added fees and interest: While you’re saving toward a settlement, creditors may continue to apply late fees and interest, which can increase balances before they are reduced. 
• No guaranteed outcome: Creditors are not required to accept settlement offers, and some may take longer to negotiate than expected. Not every debt may be resolved. 
• Collector contact or lawsuits: Creditors and collectors can continue to call or may even take legal action while negotiations are underway. 
• Tax obligations: If a creditor forgives part of your balance, the IRS may consider that amount taxable income. You could receive a 1099-C form and may want to consult a tax professional about whether an exclusion applies. 
• Scams and bad actors: Some companies make promises—such as “pennies on the dollar” savings or guaranteed results—that are misleading or unrealistic. 

Knowing these risks in advance doesn’t eliminate them, but it can help you ask the right questions and avoid companies that aren’t transparent. 

When Settlement May Not Be a Fit 

Debt settlement isn’t right for everyone. It may not be the best option if: 

• You can keep up with payments: If you’re able to pay your debts on time and in full, settlement could cause more credit damage than benefit. 
• Most of your debt is secured: Mortgages, auto loans, and other debts tied to property usually can’t be settled through these programs. 
• Your debts are excluded: Tax balances, federal student loans, or court-ordered payments like child support are generally not eligible for settlement. 

If any of these apply to you, exploring other debt relief options may be a better fit.  

Ways to Limit Risk With Any Company 

If you decide to consider debt settlement, choosing a transparent company and knowing your rights can help reduce the risks. Key safeguards include: 

• Don’t pay upfront fees: Under federal rules, debt relief companies that use telemarketing cannot collect fees until at least one debt has been settled. 
• Keep control of your account: The account holding your settlement funds should stay in your name, and no money should move without your approval. 
• Ask for clear costs in writing: A reputable company will explain how fees are calculated, when they’re charged, and provide this information in writing. 
• Get every agreement in writing: Creditors should provide written confirmation of any settlement before you pay. 
• Check how they handle collector contact: Ask what type of support is available if you continue receiving calls or if legal action is filed. 
• Confirm how tax issues are addressed: A responsible company should explain when you might receive a 1099-C. 

These steps don’t erase the risks, but they can give you more control and help you make informed decisions. 

Red Flags to Watch For 

Some companies make debt settlement riskier than it needs to be. Be cautious if you notice: 

• Upfront fees: Asking for payment before settling any debt is a warning sign. 
• Unrealistic promises: Claims such as “erase your debt,” “pennies on the dollar,” or guaranteed savings and timelines are misleading. 
• High-pressure sales tactics: If you’re told to sign quickly or that you’ll “miss out” if you wait, step back. 
• No written proof: Every settlement should come with written confirmation. Avoid companies that rely only on verbal assurances. 
• Downplaying risks: If a company says your credit won’t be affected or lawsuits can’t happen, that’s not accurate. 
• Loss of control: Be wary if you’re asked to put money into an account you can’t access. 

Seeing any of these signs should make you pause. A trustworthy company will welcome your questions and be upfront about both the potential benefits and the risks. 

Questions to Ask Before You Sign 

If you’re considering debt settlement, don’t hesitate to ask direct questions. A reputable company should give clear, written answers to things like: 

• When are fees charged, and how are they calculated? 
• Which types of debt usually don’t qualify for settlement? 
• How will you keep me updated on settlement offers and approvals? 
• What are the average program costs and timelines for people in situations like mine? 
• What support is available if a creditor files a lawsuit? 

These questions can reveal how transparent a company is—and whether they’re giving you the details you need to make an informed decision. 

Making a Safer Debt Settlement Choice 

Debt settlement carries real risks, but risk doesn’t always mean it’s the wrong choice. What matters is having honest expectations, knowing the possible downsides, and working with a company that is transparent about how the process works. 

If you decide to explore settlement, go in prepared: understand how fees are charged, which debts may not qualify, and that results can vary depending on your situation. A trustworthy company will answer your questions in writing and give you the information you need before you commit. 

National Debt Relief offers free consultations where you can learn how the program works and whether it may be an option for your circumstances. These conversations are purely informational with no obligation to enroll, so you can make your decision with confidence. 

The content provided is intended for informational purposes only. Estimates or statements contained within may be based on prior results or from third parties. The views expressed in these materials are those of the author and may not reflect the view of National Debt Relief. We make no guarantees that the information contained on this site will be accurate or applicable and results may vary depending on individual situations. Contact a financial and/or tax professional regarding your specific financial and tax situation. Please visit our terms of service for full terms governing the use this site.