Leslie Parrish and Ellen Harnick
An Introduction to Debt Settlement
D ebt-settlement companies promise to reduce consumers’ debt by negotiating with their creditors
for a fee.1 However, this promise comes with a serious risk—consumers enrolling in debt-settlement
programs must first default on their debts and then see whether the debt-settlement company
can successfully negotiate a reduction in some or all of the amount owed. Most often, clients of
debt-settlement firms seek to settle credit card debt,2 although the firms may also negotiate other
forms of unsecured consumer debt, such as private student loans and medical debt.
Debt-settlement advertisements claim that typically consumers see “over 50% of their debt written
off…” and are “…debt free in as little as 36 months” (DMB Financial, 2013). Debt-settlement
companies promote themselves as being faster and less expensive than slowly paying off credit card
debt through minimum payments and as providing a less drastic strategy than filing for bankruptcy
(Freedom Debt Relief, 2013a and 2013c; US Financial Options, 2013). However, research suggests
that these claims may not deliver for the typical borrower.
Modern-day debt settlement is just one of several ways that consumers can address unmanageable
credit obligations.3 For legal debts, consumers may obtain concessions from their creditors to make
debt repayment more manageable, either directly or through a credit counseling agency. In addition,
consumers can try to secure a resolution from a court, such as when they file for bankruptcy.
Consumers whose credit was provided illegally, e.g., by a payday lender providing a loan in a state
in which this type of credit is prohibited, can take legal action against the creditor to have the obligation
extinguished. Two key differences between debt settlement and these alternative approaches
is that the alternatives (1) do not require consumers to default on their debt and (2) give consumers
an up-front agreement, either through the legal process or with the creditor, about how the debt will
be handled, thus limiting their risk and uncertainty.