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Debt Settlement Companies - How do they work?

Updated on July 19, 2013

What is a Debt Settlement Company?

Debt Settlement Companies are companies that negotiate with creditors or collection agencies on behalf of an individual to settle the individual's outstanding debt with their creditors. They negotiate with the creditors to try to find a settlement that is acceptable to both the creditor and the individual. These are privately owned companies who are out to make a profit.

How Do Debt Settlement Companies Work?

Debt Settlement Companies get individuals who have debt that they would like to settle to sign up for their services. Sometimes the debt settlement company will have a large sign up fee. Or they may take a monthly fee for their services. Another common method is for debt settlement companies to take a percentage of the amount of debt that they save the individual, or that they get the creditor to write off. In any case, they are getting paid for their services.

Once they get the individual to sign up for their services they will begin to negotiate on behalf of the individual.


Creditors are often willing to accept reduced balances as a final payment. The amount of money that the Debt Settlement Companies are able to save the individual depends on several factors.

If the individual is able to make full payment at one time the creditors are often willing to accept a lower payment since they are getting it all up front. If they have to set up a payment plan over a certain time period they are not as willing to write off as much money.

Many times the creditors sell the debts to junk debt buyers. They are eager to settle as long as they are making a profit. They purchase the debts for a fraction of the original balance.

Once an individual has decided to use a debt settlement company, usually that company will advise the individual to stop making all payments to any of the creditors that the individual wishes to settle with. They advise them to save all of the money that would have been used on payments and either send it in to the debt settlement company directly, or hold onto it so that when they begin negotiations they will have it ready.

They will also advise the individual to come up with any other monies that they can. In the meantime, the phone calls start to come in.

Often the debt settlement companies will have the individual sign "cease and desist" letters, but in most cases the "cease and desist" letters are not legal. The individual owes the creditor money and the creditor has the right to contact the individual in an attempt to collect their money.

They also will often have them sign letters giving the creditors permission to speak directly to the debt settlement companies on their behalf. Again, the creditors do not have to speak to them if they choose not to. There are some creditors who do not deal with or negotiate with debt management companies.

Disadvantages to Using A Debt Settlement Company

There are disadvantages to using a debt settlement company. One problem is that in order to get the creditors to negotiate the account must be past due. With most creditors it must be past due for at least 90 days. So the individual's credit is affected.

Debt Settlement Companies do not handle the phone calls from the creditors or the collection agencies. They can speak to them on behalf of the individual but they must call the creditor. In the meantime, the individual gets many calls from the creditors trying to collect payment during the process of the settlement. Once a settlement has been agreed upon the calls will stop. But until then they are relentless in trying to collect their debt.

Some creditors will pursue legal action against the individual. Not all debt settlement companies work with the individuals to protect them. Some do, but some don't. Bottom line, if the creditor takes legal action the individual is the one whose neck is on the line, not the debt settlement company.

Another disadvantage is that after the debts are settled they appear on the individual's credit report as closed, but not always in a positive light. They may indicate "settled for less than the amount due" or "closed at the creditor's request". When the individual applies for credit in the future these may at the least need to be explained.

My Opinion

The first thing that comes to my mind when I think of debt settlement companies is that if it sounds too good to be true then it usually is. And I'm an optomist so for me to say that is unusual. However, to think that you can easily get rid of all your debt for pennies on the dollar just doesn't make sense. There has to be a catch and in my opinion, there is.

First of all, the debt settlement companies tend to lead people to believe that it's a fairly simple process. But getting into all of that debt took time, and getting out takes some too. I'm not saying that nobody should consider debt settlement companies. I'm just saying that the sales pitch can sometimes make it seem like you're looking thru rose colored glasses.

Not all debt settlement companies are bad but there are a lot of bad ones out there. In 2009 the New York Attorney General issued subpoenas to fourteen debt settlement companies for violations of New York State Law. The Better Business Bureau has adopted an downgrading policy for all debt settlement companies stating that they have concerns with the debt settlement industry.

Choose Wisely

If you do decide that debt settlement is the way for you make sure you do your research. Look into the company that you are thinking about using. Check out everything that you can find out about them. How long have they been doing this? How many employees do they have? What is the average length of employment for their employees? (Do they have a high turnover?) What is there training for employees? (Do the people working for you know what they are doing?) Remember, getting into debt takes time, and so does getting out.

Have You Used A Debt Settlement Company

If you have used a debt settlement company, did it work for you?

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