Put simply, debt relief is a process in which you hire a third-party company to negotiate with your creditors in an effort to reduce what you owe. If you’re deeply in debt, struggling to keep up with payments and dealing with collection calls, debt relief may be an option—but it’s by no means a magic pill and generally shouldn’t be a first recourse.
Debt relief companies typically have you stop making payments to your creditors. Instead, you set money aside in a dedicated account. Once enough money has accumulated, the company attempts to negotiate with your creditors to accept less than the full amount you owe.
Faced with the possibility of receiving nothing, creditors can agree to settle—or refuse to play ball.
What happens when you hire a debt relief company?
The debt relief company typically starts by reviewing your finances: how much unsecured debt you have, who you owe, and how much you can afford to put money aside each month.
The company will generally have you stop paying the debts you’ve asked them to settle. Instead, you’ll deposit an agreed-upon monthly amount into a dedicated account that you control.
Once enough money has accumulated for the company to begin negotiating, it approaches a creditor and offers a lump-sum payment for less than the full balance. If the creditor agrees and you approve the settlement, money from the dedicated account is used to make the payment. The debt is settled.
How much does debt relief cost—and how much could you save?
How much debt relief might be able to save you depends on what your creditors are willing to accept. For example, if you owe $10,000, it’s not out of the realm of possibility that a creditor could agree to take $6,000. But that doesn’t necessarily mean you’ve saved $4,000. The debt relief company will charge its own fees for negotiating the settlement.
Under federal law, debt relief companies covered by the Telemarketing Sales Rule can’t collect these fees upfront. They do, however, have to tell you what the service will cost before you sign up.
The company can collect a fee only after it has successfully settled or otherwise resolved a debt, you’ve agreed to the settlement and you’ve made at least one payment to the creditor.
What are the fees involved in debt relief?
Let’s say as an example that the company you’ve hired charges a fee equal to 20% of the $10,000 debt you enrolled. That would add $2,000 to the cost of resolving the debt. So, in this scenario, while your creditor accepted $6,000, you would ultimately pay $8,000 between the settlement and the company’s fee.
You generally shouldn’t have to suddenly come up with another $2,000 when a settlement agreement is reached. A debt relief program may calculate your monthly deposits so that you’re setting aside enough money to cover both your settlements and the fees the company expects to earn.
Once the company has successfully settled a debt and met the requirements to collect its fee, that fee can be paid from the money you’ve accumulated in the account.
What are the risks of debt relief?
Working with a legitimate debt relief company could rid you of your debt, stop the collection calls and allow you an opportunity to start fresh with your financial habits.
However, even if your debt relief program is successful, there are likely to be negative consequences—particularly for your credit. And if debt relief isn’t successful, you could wind up in a worse position than where you started.
What happens if debt relief works?
Your credit will take a hit. Because debt relief typically involves stopping payments to your creditors, months of late or missed payments can appear on your credit reports.
Settling the debt doesn’t erase that history, and just because an account balance is at zero doesn’t mean it’s been paid in full. The account may be reported as settled, indicating that the creditor accepted less than the full amount owed. Negative marks like this can remain on your credit reports for years.
The good news is that the damage doesn’t have to be permanent. You can work to rebuild your credit over time once the debts are resolved.
What happens if debt relief doesn’t work?
There’s no requirement that your creditors negotiate with a debt relief company or accept a settlement. A creditor could certainly decide to reject the company’s offers entirely.
Meanwhile, you may have gone months without making payments. Interest and late fees can pile up, collection efforts may persist and your credit can deteriorate further.
That creates the central risk of debt relief: You can follow the program, set money aside and endure the consequences of missed payments without any guarantee that a creditor will ultimately agree to settle.
Is debt relief a good fit for you?
If all of this sounds like a raw deal, take a careful assessment of your situation and consider whether you have better options on the table. If you are more or less continuously able to make monthly payments, debt consolidation or a debt management plan (working with an accredited nonprofit credit counselor) may help make them more affordable without requiring you to stop paying your creditors.
Debt relief can make more sense, even with its downsides, when you have substantial unsecured debt, can no longer keep up with the minimum payments and don’t realistically see a way to repay the full balances. Additionally, your credit may already be badly damaged, making the potential credit consequences of debt relief less of a deterrent.
Be aware you still need enough income to regularly set money aside for settlements. If you can’t afford to do that, your situation might merit discussing bankruptcy with an attorney.
The takeaway
Debt relief is a tradeoff. You may be able to settle your debts for less than you owe and get out from under payments you can no longer afford. In exchange, you’ll pay fees, your credit will likely take a big hit, and there’s no guarantee your creditors will even agree to settle.
For someone who still has the means to repay their debts, those risks may not be worth taking. But if you feel trapped in a dark tunnel of debt and financial stress with no conceivable end in sight, debt relief may be worth considering as a potential way to move forward.
Frequently asked questions
Can creditors refuse to work with a debt relief company?
Yes. Creditors aren’t required to negotiate with a debt relief company or accept a settlement offer. If a creditor refuses, you could still owe the full balance, along with any interest and fees that accumulated while you weren’t making payments.
What types of debt can debt relief help with?
Debt relief generally focuses on unsecured debts, such as credit card balances, unsecured personal loans and some medical debts. Secured debts, such as mortgages and auto loans, generally aren’t eligible because they’re backed by collateral.
Do you have to pay taxes on debt forgiven through debt relief?
Possibly. The IRS generally considers canceled debt taxable income, although exceptions and exclusions can apply. If a creditor forgives $600 or more, you may receive Form 1099-C showing the canceled amount.