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Debt settlement costs vary from one company to another, but it’s common to pay 15% to 25% of the debt the company negotiates on your behalf.
The right debt relief company might be able to negotiate with your creditors and convince them to accept less than you owe—typically in a lump sum—to satisfy your debt. Yet there are no guarantees that your creditors will accept any settlement offers. Debt relief efforts can also trigger tax consequences and serious credit score damage. It’s important to consider all these details before proceeding.
Key Takeaways
- Debt settlement costs often range from 15% to 25% of the debt (either the initial debt or the settled debt).
- Before you hire a debt relief company, it’s important to understand the costs and risks associated with these types of services.
- Like any major expense, shop around before hiring a professional debt relief company to represent you.
- Protect yourself by learning to recognize the signs of debt settlement scams.
How Much Does a Debt Settlement Program Cost?
Generally, debt settlement companies charge fees based on a percentage of your debt. These fees are usually from 15% to 25% of the total debt you enroll in the program, though some reach as high as 30%. Some debt settlement programs charge this fee based on the initial amount of debt you bring into the program, while others charge based on the amount of settled debt.
This is an important distinction, so be sure to understand how a debt settlement company charges before deciding to work with them. If a debt settlement company agrees to take on $20,000 of your debt, for example, and charges based on enrolled debt and settles for $10,000, you could pay up to $5,000 or more in fees (25% of $20,000 = $5,000 in debt settlement fees). But if the company charges based on settled debt, you’d pay $2,500 in settlement fees (25% of $10,000 = $2,500 in fees).
Other details may affect your total debt settlement costs, too. For example, your state of residence (and the laws that govern debt settlement in that state), the total amount of debt you enroll in a program, and your creditors’ willingness to negotiate can all impact the price you pay for services.
No matter how a debt settlement company chooses to charge you, it cannot collect fees upfront. A debt settlement program must first perform its promised services before it’s allowed to collect fees from you, thanks to federal regulations. Companies that don’t comply are subject to legal action.
You’ll typically need to deposit payments into a third-party escrow account to build up funds for the lump-sum settlement. You can get these deposits back with no penalty if you decide to cancel the program before a settlement. However, you may need to pay setup and/or monthly fees for this account; those fees are legal and unlikely to be refundable because they’re not going to the debt settlement company.
While these fees may seem excessive, debt settlement might help you save money in certain situations. According to a study by the American Association for Debt Resolution (AADR), the average client receives around $2.60 to $2.70 in debt reduction per $1.00 in fees paid for debt settlement services—that’s $1.60 to $1.70 in total savings per dollar of debt negotiated.
It’s important to crunch the numbers before you accept any settlement offer to make sure it makes sense and compare debt settlement to other options like credit counseling and bankruptcy. Debt settlement and bankruptcy can each have significant negative effects on your credit, but debt settlement may be more expensive.
Best Debt Relief Companies
Risks of Debt Settlement Programs
When you’re feeling overwhelmed by debt, having a professional step in and negotiate with creditors on your behalf can certainly sound appealing. But debt settlement also carries risks.
- Credit damage: Debt settlement can negatively affect your credit. When you join a debt settlement program, the company will most likely advise you to stop paying your creditors while you save money and the company attempts to negotiate settlements for less than you owe. Not paying your credit obligations as promised can cause late payments on your credit reports, credit score damage, charge-offs, and other negative credit-related consequences. This type of credit damage can last a long time.
- Other costs: When you stop paying your credit obligations, creditors are likely to add late fees to your accounts. You also risk lawsuits from creditors when you fall far enough behind on your bills.
- Tax implications: There’s another potential expense to be aware of when you hire a professional to negotiate on your behalf: the tax consequences of debt settlement. The IRS may treat reductions in the debt you owe (aka settled or forgiven debt) as income you need to claim on your tax return. If you settle $3,000 in credit card debt for $1,500, for example, you might have to claim the $1,500 in forgiven debt as income and pay taxes on that amount.
- No guarantees: Creditors don’t have to accept settlement offers from debt relief companies. So, there’s no promise that hiring a professional to negotiate on your behalf will resolve your debt issues.
“The biggest risk is that debt settlement isn’t guaranteed and may not work for you,” said Misty Lynch, CFP and owner of Sound View Financial Advisors. “This could leave you with the same (or more) debt if you haven’t been paying during the time you were trying to negotiate.”
How Much Does It Cost to Settle Your Debts Yourself?
You have the right to attempt to settle your debts on your own, without paying anyone to represent you. In fact, if a debt settlement company doesn’t let you know that you can settle your own debts, it’s a red flag.
There’s technically no cost to settle debts yourself. But if you don’t pay your debts on time and attempt to settle, you could face late fees, potential lawsuits, and other negative consequences just like you might when you hire a professional debt relief company.
At the same time, it’s important to be honest with yourself. If you’re dealing with unmanageable debt and you don’t have the time or ability to negotiate with your creditors, hiring a trustworthy debt settlement company might be worth the accountability it provides.
When Should You Work With a Debt Settlement Company?
Working with a debt settlement company involves serious risk to your finances and your credit score. As a result, you should only consider this approach if you’ve exhausted all other options.
“If you’re facing a situation where you can’t keep up with your payments and it’s tough to see a way out, that’s when you might consider a debt settlement company,” said Ashton Lawrence, CFP, director/senior wealth advisor of Mariner Wealth Advisors. “For some people, it would make sense. For others, it may not.”
Debt settlement could be an option for people with significant unsecured debt, like credit cards. But you also need enough space in your budget to build up funds to negotiate with your creditors. An experienced debt settlement company might also have better outcomes when negotiating with creditors in certain cases.
Signs of a Debt Settlement Scam
If you’re considering debt settlement, familiarize yourself with the signs of potential scams to protect yourself against people with bad intentions.
You should avoid working with any debt settlement company that:
- Contacts you first
- Charges upfront fees prior to settlement (initial or ongoing fees for the escrow account do apply in some cases, as noted above)
- Makes unrealistic promises (e.g., “We’ll wipe out all of your debts”)
- Fails to warn you of the potential consequences of settling your debts such as lawsuits, collection accounts, credit damage, tax implications, and more
“Debt settlement scams target vulnerable people who are desperate for help,” said Lynch. “They prey upon the guilt and shame attached to debt and know that people who already feel bad and then get scammed will blame themselves. If you are contacted by a debt settlement company, that is a red flag. You want to be proactive in this process—not reactive.”
How Much Do Debt Settlement Alternatives Cost?
Before you decide to hire a debt settlement company, you may want to consider other ways to manage your debt. Here’s a look at some debt settlement alternatives and how much they cost.
- Debt consolidation: If you have good credit, you might be able to qualify for a personal loan or a balance transfer credit card to consolidate your debt at a lower interest rate. With debt consolidation loans, you’ll pay interest and possible origination fees. (A loan calculator can help you estimate costs.) A balance transfer credit card with a 0% APR promotion may help you avoid interest for a limited time. But these offers typically include balance transfer fees—often 3% to 5% of the amount you transfer to the new account.
- Credit counseling: A credit counseling program is another way to address overwhelming debt. These programs may be able to help you set up a debt management plan (DMP) with your creditors to reduce interest, waive fees, and pay off your credit obligations at a more affordable pace. Monthly fees for credit counseling DMPs can vary widely—often from $0 to $75. You may also have to pay an initial fee to join a DMP. Plus, you’ll need to continue making payments to your creditors.
- Bankruptcy: Filing bankruptcy can offer you protection and relief when you can no longer afford to pay your credit obligations. But bankruptcy can have a long-term impact on your credit and your finances. Hiring an attorney to help you file bankruptcy may cost several thousand dollars, depending on your situation. You may also have to pay several hundred dollars in filing fees to the court.
“Debt settlement should be a last resort,” said Lawrence. “It can have consequences, so exploring other options first is wise.”
The Bottom Line
Depending on your situation, working with a professional debt settlement company might save you money. But there are risks to weigh before you proceed down this path.
Consider debt settlement costs and make sure they fit your budget. Remember that you’ll have to pay a significant amount in fees for any savings you get. If you decide that debt settlement is right for you, it’s wise to compare multiple debt settlement providers to find the best deal available and to avoid potential scams.
What Is the Average Cost of Debt Settlement?
Based on Investopedia research, minimum debt settlement fees often start at around 15% of the debt. Maximum debt settlement fees are commonly around 25%, though they could go as high as 30% in some cases. See our picks for the best debt relief companies to find some options with fees on the low end.
Can Debt Settlement Companies Charge Upfront Fees?
In 2010, the Federal Trade Commission prohibited debt settlement companies from collecting upfront fees for their services. As a result, these companies must now settle your debts first before charging you.
However, it’s common for debt relief companies to require you to deposit funds into an escrow account during your membership—and you may have to pay a fee to maintain this escrow account each month. In general, the company won’t attempt to negotiate with creditors on your behalf until you deposit enough cash into your escrow account to cover lump sum settlement offers plus your debt settlement costs.
What Factors Affect the Cost of Debt Settlement?
Debt settlement fees are a percentage of the debt, and the amount charged can vary from one company to the next. Factors such as the total amount of debt you have, state laws, and other details may impact the total amount you pay.
What Percentage Should I Offer to Settle Debt?
There’s no magic formula when it comes to debt settlement offers. The type of debt and the degree of delinquency could have an impact on how creditors respond to negotiations.
You may want to consider starting with a lump sum offer of 25% to 30% of the total amount you owe. Often, creditors will counteroffer with a higher amount. So, if you start with a lower offer, it could give you some wiggle room to negotiate.
Another strategy to consider is asking the creditor if it’s willing to settle and, if so, for how much. From there, you could counteroffer with a lower settlement amount and see if the creditor is willing to accept.
Do I Have to Pay Tax on Settled Debt?
Whether you hire a debt settlement company or settle debts on your own, you may have to pay taxes on forgiven debts. The IRS states that if a creditor cancels, forgives, or discharges your debt for less than the amount you owe, the amount of the canceled debt is taxable.