Debt settlement is a form of debt relief that promises clients they will only need to pay back a small portion of the total amount of credit card debt they owe. It’s an especially appealing idea for those who are carrying balances on multiple high-interest credit cards.

The for-profit companies offering debt settlement make many attractive promises. But the reality of the debt settlement process may be more than some folks bargain for. Let’s look at debt settlement pros and cons.

PROS

Pay Less Than You Owe

The biggest draw of participating in a debt settlement program is paying less than the total amount you owe. If you’re carrying large balances on multiple cards or — even a single large balance on one card — the thought of the card being “paid in full” without actually doing so may pique your curiosity.

Get in the Savings Habit

Part of the debt settlement process is setting aside funds into a dedicated savings account every month. This is the money the settlement company will use to pay your creditors once they reach a settlement agreement.

This is a great way to get into the habit of saving money every month. It’s something you should continue to do even after you complete debt settlement, whether you’re building an emergency fund or saving for something special like a vacation or major purchase.

CONS

Upfront and Ongoing Fees

Debt settlement plans are offered and managed by for-profit companies. In addition to the fees they charge for setting you up on the plan, there are also ongoing monthly charges. Since the whole process can take up to four years to complete, you’ll be spending a lot of money in fees that could be better spent paying down your debt.

Damage to Payment History

One of the first things many debt settlement companies advise their clients to do is stop making credit card payments. Then they use the delinquencies as a negotiating tactic to get the creditors to accept less than the full amount you owe.

The main problem with this is the effect it has on your credit. Payment history makes up the largest portion of your credit score. Even one late payment on one account can cause your score to drop. So just imagine allowing multiple accounts to slide into delinquency. Yikes!

Higher Total Debt

Interest on your account balances will continue to accrue throughout the settlement process. And you could face late payment fees, too. By the time all parties agree to a final settlement agreement, you may end up owing more than you did when you started.

Overall Damage to Credit

Debt settlement can damage your credit in several ways. In addition to damage from late payments, settled accounts will be noted as such on your credit report. This is a red flag to future lenders that you may be a bad credit risk. The notations of settled accounts stay on your credit report for seven years. While the negative impact lessens over time, it will initially be challenging to obtain new credit at reasonable interest rates.

Key Takeaways

When it comes to debt settlement, the cons outweigh the pros. While it is one way to get rid of problem debt, it can have long-lasting negative effects on your credit that negate the benefits of paying less than you owe.

Be sure to weigh the pros and cons of all debt relief options — including debt management plans — before you begin the debt settlement process.