What Is Debt Settlement And How Does It Work?

by Business Published on: 03 February 2023 Last Updated on: 11 August 2023

Debt Settlement

You might be stuck in a debt plunge and wonder what the way out is. Debt settlement presents as one amongst many alternatives to your financial distress. So, what is debt settlement and how does it work?

Debt settlement is a negotiation process between a borrower and a creditor, where the debtor’s fee is waived, and the remaining amount is settled all at once. A debtor may hire a third party for negotiations or do it themselves. Through a settlement process, the lender can settle the withstanding debt balances.

The principal debt balance and interest rates are significantly lowered with debt settlement. Below is how debt settlement works;

1. Consult a Settlement Company

A debt settlement company is a liaison between the creditor and the debtor. Before you consult a settlement firm there are a couple of things you need to investigate to see if you are choosing one of the best debt settlement companies in your area. Here are the big things you need to look for when hiring–

  • A good track record of previous services
  • An experience in the business, preferably five years or more
  • The best business bureau. Best business bureaus are independent, have fewer claims, and resolve complaints.
  • Good professionalism; How do they approach you? Are they keen on your issue or just money? And, how professional are their representatives?

Since these companies offer charges for their services, opt for a company whose charges are reasonable.

When you consult a settlement company, they will do a debt analysis to know your outstanding debt, income, and monthly expenses. This phenomenon allows the settlement company to curate a realistic monthly payment plan for you that will contribute toward a perfect freedom debt solution.

2. Review and Approval of the Plan

The settlement company a review and approves the plan after a debt analysis. A personalized payment plan is created and given to you for approval. Some renowned settlement companies like Freedom Debt Relief have online estimate calculators that you can use to estimate your personalized plans. Such settlement companies are recommendable due to the transparency of their services, which helps you to understand how the program runs.

As a debtor, you must agree to the terms upon arrival of a settlement: a reduced one-time amount, debt discharge, and reduced monthly installments. However, you have no obligation to agree to these terms. Upon review and approval of the plan, you will need to make monthly installments to the settlement company until you settle the entire debt. You may put forward any inquiries before the completion of your enrollment.

3. Make Monthly Payments

Typically, debt settlement companies will ask you to make monthly payments to a savings account, like escrow. The money will be useful to negotiate your principal debt balance with your creditor. Sometimes, a good settlement company gives you entitlement to interest earned from your savings account and balance withdrawal. Usually, the account administrator and a debt settlement company operate independently.

By this time, you have stopped making debt payments directly to your creditor and instead make monthly payments to your savings account. The downside is the interest rate and fees charged for late payments accrue. At the same time, your settlement company is charging you a closing fee. This may, in turn, affect your overall credit scores.

4. Settlement Company negotiates with your creditors

After your savings attain a given threshold, settlement companies will approach your creditors. The settlement companies negotiate with your creditors on debt settlement by making a one-time payment.

Usually, their negotiations are from the point of the creditors receiving a partial payment instead of risking losing the entire amount. The implicit is if the lender files for bankruptcy, creditors will not collect anything from them. The result is a free debt solution for both the creditor and the lender.

If the settlement company’s negotiation with your creditors is successful, it makes a one-time payment to your creditors and settles the debt. Usually, the settlement company will reserve up to 25% of your debt and charge an extra amount as a maintenance fee for your savings account.

When a settlement company negotiates with your creditors, they aim to pay the creditors up to a quarter less the principal debt balance. Consequently, you end up saving more and clearing your debt.

The Bottom Line

In conclusion, if you are a distressed debtor, consider asking yourself, what is debt settlement and how does it work? This step will be the start of your financial freedom. Additionally, Choosing the right settlement company is key to your freedom debt solution. You will save on principal debt, reducing your chances of going bankrupt.


With an adept skill of curating content on multiple genres, Mony has harnessed success as a Content Writer. Find her sharing profound thoughts and opinions on business and startups. She also loves talking about lifestyle, beauty and fashion.

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