The Short and Long-term Effects of Debt Settlement:

Stressed Man Looking At Too Many Credit Cards In Home

DISCLAIMER: As the COVID-19 public health situation evolves, new regulations are being continually issued. This page/story/information may not include the most recent information.

The Short and Long-term Effects of Debt Settlement: What consumers can expect through the process and how long it may take to rebound

By Bruce McClary | Tuesday May 12th, 2020

Debt settlement can be very tempting. If you have debts to your name, the promise of paying them off at a steep discount (maybe even for “pennies on the dollar”) probably sounds like a dream come true. However, reality may be much more like a nightmare. Debt settlement can be a long, drawn out process without much success in the short-term. Not only that, but it can have lasting negative financial impacts for years to come. Since there are not many short-term or long-term benefits, it is probably best to consider a different solution altogether. That said, here is a closer look at what to expect if you choose to pursue debt settlement.

Short Term: Stress Goes Up, Credit Score Goes Down

First, let’s take a look at the short-term effects of debt settlement. And to do that, let’s paint the scene for how you are probably feeling if you are contemplating the idea of working with a debt settlement agency: you are behind on numerous bills, you want nothing more than peace of mind and to see a light at the end of the tunnel, and you are sick and tired of nagging phone calls from creditors and third-party debt collectors. You are not just tired of owing money and not making ends meet—you are also tired of your credit score taking a beating, and you worry about how you will rebuild your credit in the future. In short, you are stressed out!

Unfortunately, the short-term effects of debt settlement will likely make this situation even more stressful for you. Debt settlement typically requires you to miss months of payments on your debts intentionally, forcing your accounts to fall farther behind. You will be ignoring your bills and letting them pile up more and more, so that the settlement agency can use that as negotiation. Essentially, a debt settlement agency wants to make you look like you are in bad shape—they want to tell creditors that your accounts are lost causes that will never be paid off in full. This might convince some creditors, but only after an extended period of missed payments. During this time, your creditors will most likely continue attempts to collect your debts as your balances grow. You may even be at risk of legal action that could even lead to wage garnishment. This will only create a more stressful situation!

Not only will those worsening circumstances cause your financial stress increase, but your credit score will take a serious hit. The impact to your credit score may be immediate and severe. Every time you miss a payment to a creditor, beyond 30 days after the due date, that can be reported to the credit bureaus as a negative mark against you. On top of that, “Payment History” is the most heavily weighted factor in the FICO scoring model, so negative marks for missed payments can have a significant impact. This problem becomes worse when you are dealing with multiple creditors. As Experian explains, “[m]issing multiple payments in a row can be worse for your credit than missing one payment,” and “[h]aving late payments on multiple accounts can be worse than a late payment on a single account.” In other words, damage to your credit score will pile up quickly and can lead to a high number of new negative marks on your credit report.

Long-Term: Low Success Rate and High Fees

The short-term effects of debt settlement are not great. But life is a marathon, not a sprint, right? You might think, and settlement agencies certainly want you to, that the short-term sacrifices are worth it for long-term success. In the case of settlement, long-term success would mean having your debts considered paid in full even though you did not pay the full balance. “Success” would also include rebuilding your credit and being able to work toward your other financial goals. However, in most cases, debt settlement fails to achieve either of these long-term goals.

First, let’s take a look at your credit score again. Like previously mentioned, it will take a beating in the short-term, but those effects are long-lasting. The missed payments will remain on your report for seven years from the original delinquency. Seven years is a long time, and will provide opportunities to improve your score, but the negative marks that the debt settlement business model essentially requires will haunt you for a long time.

As for the settlement overall, your results may vary. You should know that very few consumers are able to settle all of their debts. In fact, more than 90 percent of consumers do not settle all their debts, which means you will probably be on the hook for some of your debts in full. The worst part of that scenario is that the unsettled accounts are left for you to deal with at a point when they are much farther past due than when you started the process. Even if you do settle some of your debts, it will take a very long time. A recent study indicated that consumers only settle 43 percent of their debts by the third year of the settlement process.

Not only is debt settlement unlikely to work quickly and unlikely to cover all your debt, but it is also expensive. You can expect to pay fees in the range of 15 to 25 percent of your enrolled debt. On top of this, forgiven debt is most likely to be considered taxable income. So, if you settle a debt, you will pay your creditor the agreed lump sum, then pay a 15 to 25 percent fee to the agency, and then pay a tax bill.

A Finish Line?

Debt settlement is a long, tough road. As soon as you start down the path, you will face obstacles and serious negative impacts to your credit score, along with the potential for lawsuits and garnishments. Even if you get over these hurdles, you are not in the clear. You should prepare for a minority of your creditors to agree to settlement. This will leave you planning to pay many of your creditors back in full. Even when settlement is successful, it will come at a cost of fees and increased tax liability.

If you want to cross the finish line in pursuit of your financial goals, you are better off avoiding debt settlement altogether. Even if you have started a settlement program, it may not be too late to make a change. Familiarize yourself with the variety of debt relief options available (download our Ultimate Debt Relief Comparison Whitepaper), and contact a credit counselor for free help as you decide the best way to move forward.

When you’re in a bind financially, of course a quick fix will sound like a great solution. But, debt settlement is actually far from a “fix” in most cases.


Michigan license number:   DM-0016282 Available to the public and licensed in Michigan.

Section 13(1)  When a licensee establishes a debt management plan for a debtor, the licensee may charge and receive an initial fee of $50.00

Section 13(2)  A licensee shall attempt to obtain consent to participate in a debt management plan from at least 51%, in number or dollar amount, of the debtor’s creditors within 90 days after establishing the debt management plan. If the required consent is not actually received by the licensee, the licensee shall provide notice to the debtor of the lack of required consent and the debtor may, at its option, close the account. If the debtor decides to close the account, any unexpended funds shall be returned to the debtor or disbursed as directed by the debtor.

Sec. 14. (1) A contract between a licensee and debtor shall include all of the following:

(a) Each creditor to which payments will be made and the amount owed each creditor. A licensee may rely on records of the debtor and other information available to it to determine the amount owed to a creditor.

(b) The total amount of the licensee’s charges.

(c) The beginning and termination dates of the contract.

(d) The principal amount and approximate interest charges of the debtor’s obligations to be paid under the debt management plan.

(e) The name and address of the licensee and of the debtor.

(f) Any other provisions or disclosures that the director determines are necessary for the protection of the debtor and the proper conduct of business by a licensee.

Sec. 18. (1) In addition to the fee described in section 13(1), a licensee may charge a reasonable fee for providing debt management services under a debt management plan. The fee under this subsection shall not exceed 15% of the amount of the debt to be liquidated during the express term of the plan.

(2) A licensee may offer a debtor the option to purchase credit reports or educational materials and products, and charge a fee to the debtor if the debtor elects to purchase any of those items from the licensee.  Fees charged under this subsection are not subject to the 15% limitation on fees described in subsection (1).

(3) Except for a cancellation described in subsection (4), in the event of cancellation of or default in the performance of the contract by the debtor before its successful completion, a licensee may collect $25.00 in addition to any fees and charges of the licensee previously received by the licensee. This $25.00 fee is not subject to the 15% limitation on fees and charges under subsection (1).

(4) A contract is in effect when it is signed by the licensee and the debtor and the debtor has made a payment of any amount to the licensee. The debtor has the right to cancel the contract until 12 midnight of the third business day after the first day the contract is in effect by delivering written notice of cancellation to the licensee. A cancellation described in this section is not subject to, and a licensee shall not collect, the fee described in subsection (3).

(5) If a debtor fails to make a payment of any amount to a licensee within 60 days after the date a payment is due under a contract, the licensee may, in its discretion, cancel the debt management contract if it determines that the plan is no longer suitable for the debtor, the debtor fails to affirmatively communicate to the licensee the debtor’s desire to continue the plan, or the creditors of the debtor refuse to continue accepting payments under the plan.

(6) A licensee shall not contract for, receive, or charge a debtor an amount greater than authorized by this act. A person that violates this subsection, except as the result of an inadvertent clerical or computer error, shall return to the debtor the amount of the payments received from or on behalf of the debtor and not distributed to creditors, and, as a penalty, an amount equal to the amount overcharged.

530 W Allegan Street, 7th Floor
Lansing, MI  48909-7720

Credit Advisor Logo 3

Schedule a Call Back

Credit Advisor Logo 3

Get Help Now!