Could Debt Settlement Resolve Jane Doe's $34,467 of Credit Card Debt?
Jane has $34,467 in credit card debt at an average interest rate of 24.52%. Her household budget is already running short each month, and she is looking for a way to dramatically reduce what she ultimately has to repay.
That is exactly what makes debt settlement sound so attractive.
Instead of repaying every dollar she owes, Jane enrolls with a for-profit debt settlement company. The company tells her it will attempt to negotiate with her creditors and convince them to accept less than the full balances.
For this case study, we're assuming the company estimates settlements equal to approximately 40% of Jane's enrolled balances, a program deposit of roughly $535 per month, and an estimated 36-month program.
Those numbers sound extremely appealing.
But unlike a Debt Management Plan, getting to the settlement can require Jane to stop paying her creditors and allow her accounts to become delinquent. That creates some serious consequences.
Meet Jane Doe
Jane's household brings home approximately $8,441.86 per month, while her reported monthly expenses total approximately $8,686.
That leaves her approximately $244 short each month before dealing with unexpected expenses.
Jane's Monthly Expenses
| Expense Category | Monthly Amount | Percentage of Income |
|---|---|---|
| Housing | $2,474 | 29.3% |
| Food / Groceries | $1,250 | 14.8% |
| Debt Payments | $2,925 | 34.6% |
| Auto | $672 | 8.0% |
| Insurance | $430 | 5.1% |
| School / Childcare | $200 | 2.4% |
| Clothing & Gifts | $80 | 0.9% |
| Savings / Investments | $25 | 0.3% |
| Entertainment | $630 | 7.5% |
Why debt settlement catches Jane's attention: she desperately needs a lower monthly payment. A proposed deposit near $535 is far easier to fit into her current budget than the approximately $1,223 she is paying to her targeted credit cards today.
Debt Settlement Doesn't Eliminate Jane's Other Financial Obligations
Jane's targeted $34,467 of credit card debt is only one part of her overall financial situation.
Her household also has mortgage debt, vehicle debt and student loans. Those obligations continue regardless of what happens to her credit cards.
Jane therefore needs a debt strategy that does more than create a smaller monthly number.
She needs to understand what happens while she is waiting for settlements, how her credit is affected, what happens if creditors refuse to settle, and whether she has enough cash available when settlement opportunities arise.
$34,467 of Credit Card Debt at 24.52% APR
Jane's five targeted credit card accounts total $34,467.
Those accounts carry an average APR of 24.52%, and Jane is currently paying approximately $1,223 per month.
About $704.36 per month is being consumed by interest and fees, leaving only approximately $518.59 to reduce principal.
What Happens If Jane Enrolls in Debt Settlement?
Jane contacts a for-profit debt settlement company.
Rather than continuing to make normal monthly payments directly to her credit card companies, Jane is instructed to accumulate money that can eventually be used to make settlement offers.
The theory is that once accounts become sufficiently delinquent and enough money has accumulated, creditors may become willing to accept less than the full amount owed.
For this hypothetical Jane Doe scenario, we're assuming the company estimates that her accounts could eventually settle for approximately 40% of the enrolled balances.
Debt Settlement Estimate: About 40% of Jane's Debt
Forty percent of Jane's current $34,467 balance equals approximately:
That is a dramatic reduction from the amount Jane currently owes.
But there is an important distinction:
A debt settlement company cannot guarantee that Jane's creditors will agree to settle for 40%. Individual creditors may accept more, accept less, delay negotiating or refuse to settle altogether.
The Consumer Financial Protection Bureau warns that debt settlement companies cannot guarantee what percentage of a debt a creditor will ultimately accept. Learn more from the CFPB about debt settlement .
The Good: Debt Settlement Could Significantly Reduce Jane's Repayment Amount
The strongest argument for debt settlement is simple: Jane may ultimately repay substantially less than the full balance she owes.
Debt Settlement Gives Jane a Much Lower Monthly Target
For this scenario, we're assuming the debt settlement company estimates that Jane should deposit approximately $535 per month toward the program.
For Jane, that is a huge difference.
Her current targeted credit card payments total approximately $1,223. A $535 estimated program deposit would reduce that monthly burden by approximately $688.
Jane Could Be Finished in About 36 Months
The hypothetical debt settlement program estimates a 36-month timeframe.
That is shorter than the five-year Debt Management Plan modeled in Jane's financial analysis.
If Jane successfully settles every enrolled account according to the company's projections, she could theoretically resolve the targeted credit card debts in approximately three years.
The Proposed Settlement Amount Is Much Lower Than the Current Balance
A 40% settlement estimate means approximately $13,787 of settlement payments on Jane's current $34,467 enrolled balance.
That is a potentially substantial principal reduction.
The Good:
- Jane's estimated monthly deposit falls to approximately $535.
- That is about $688 lower than her current $1,223 card payments.
- The proposed program lasts approximately 36 months.
- A hypothetical 40% settlement would equal approximately $13,787.
- If every settlement succeeds as projected, Jane could repay substantially less than the full balances.
Debt Settlement Fees Reduce Some of Jane's Apparent Savings
The $13,787 settlement estimate is not necessarily Jane's total cost.
For-profit debt settlement companies charge fees for negotiating settlements.
For this Jane Doe example, we'll assume a fee equal to 15% of Jane's enrolled debt.
The exact math is:
If settlements totaled about $13,786.80 and Jane ultimately paid about $5,170.05 in settlement-company fees, the combined hypothetical amount would be approximately:
A $535 monthly deposit over 36 months equals approximately $19,260, which is reasonably close to this hypothetical settlement-and-fee model.
Actual programs may include different fees, creditor outcomes, account charges or timing, so the final amount could be different.
Federal rules generally prohibit many telemarketed debt settlement companies from collecting their settlement fee before they have successfully settled or otherwise resolved at least one debt and other requirements are met. Review the FTC's debt settlement guidance .
The Bad: Debt Settlement Can Severely Damage Jane's Credit
The low projected payment comes with a major tradeoff.
Debt settlement programs commonly rely on consumers stopping their normal payments to the creditors while they accumulate enough money to make settlement offers.
That means Jane's accounts begin becoming delinquent.
Jane Stops Paying Her Credit Cards
Jane currently has a hypothetical credit score of 675 and is largely current on the targeted accounts.
If she stops making the required payments, creditors can begin reporting late payments and delinquencies.
Thirty-day late payments can become 60-day late payments. Then 90 days. Then 120 days or more.
Accounts may ultimately be charged off and transferred or sold to collection agencies.
For someone like Jane who begins the process with a 675 score, the negative credit reporting could be significant.
The CFPB warns that stopping payments as part of a settlement strategy can negatively affect credit scores and may result in increased collection activity. Read the CFPB's consumer warning .
Jane's Accounts Will No Longer Be Available for Normal Use
Jane should expect the enrolled credit card relationships to effectively end.
Cards may be closed by the creditors as they become delinquent, charged off or settled.
Unlike the Debt Management Plan, however, the closure occurs alongside months of missed payments rather than through a structured creditor repayment arrangement.
Debt Settlement Can Take Months Before Jane Sees the First Result
Jane begins depositing money into the settlement strategy, but creditors do not immediately accept offers.
For this case study, we're assuming Jane may wait six months or longer before seeing her first completed settlement.
During that waiting period, her accounts may continue becoming more delinquent. Interest, penalty rates and late fees may continue accumulating where applicable.
By comparison, a Debt Management Plan starts sending payments to creditors immediately after enrollment, and creditor proposals are generally reviewed much earlier in the process.
The Settlement Company's Fee Is Significant
Under our hypothetical 15% fee assumption, Jane would pay approximately $5,170 for the settlement company's services.
That fee is substantial relative to the amount she hopes creditors will forgive.
And importantly, paying a debt settlement company does not guarantee that every creditor will settle.
The Ugly: Debt Settlement Exposes Jane to Lawsuits and Tax Consequences
This is where the risk becomes much more serious.
Jane still legally owes the credit card balances while she is waiting for settlements.
A debt settlement company cannot force a creditor to wait.
It also cannot force a creditor to accept the proposed settlement.
A Creditor Can Sue Jane While She Waits for Debt Settlement
Once Jane stops making payments, creditors and debt collectors may increase collection activity.
They may call, send letters, assign the account to a collection agency or file a lawsuit seeking payment.
Enrolling with a debt settlement company does not provide legal protection from creditors. A creditor can still pursue collection and may sue Jane for an unpaid account.
The FTC specifically warns that consumers may be sued while waiting for settlement funds to accumulate. Read the FTC's debt settlement warnings .
A Judgment Could Lead to Wage Garnishment or Other Collection Remedies
A lawsuit does not automatically mean Jane's wages are garnished.
Typically, a creditor or collector must first sue and obtain a judgment. Available post-judgment remedies then depend on federal and state law.
Where permitted, those remedies can include wage garnishment, bank-account collection or liens.
That means Jane could be diligently saving money for settlements while one creditor independently pursues a court judgment.
Forgiven Debt Can Create an Income-Tax Issue
There is another cost that is easy to overlook.
Suppose Jane owes $10,000 on a credit card and the creditor accepts $4,000 as settlement in full.
Approximately $6,000 has been canceled.
Under federal tax rules, canceled debt is generally taxable income unless an exception or exclusion applies.
Jane's Hypothetical Canceled Debt
Jane begins with approximately $34,467 in enrolled balances.
If every creditor hypothetically accepted 40% of the balance:
That does not mean Jane will automatically owe income tax on $20,680.20.
Certain exclusions may apply. For example, the IRS provides an insolvency exclusion in qualifying circumstances.
But Jane should understand the tax issue before assuming that every forgiven dollar is simply free money.
The IRS explains that canceled debt generally must be reported as income unless an exception or exclusion applies. Learn about canceled debt from the IRS .
Debt Settlement: The Good, The Bad and The Ugly
The Good
Jane's estimated program deposit is only about $535 per month compared with her current $1,223 in card payments. A hypothetical 40% settlement would equal approximately $13,787, and the estimated program length is only 36 months.
The Bad
Jane generally stops making normal creditor payments, causing serious delinquencies and potentially substantial credit-score damage. She may wait six months or longer for the first settlement, and our hypothetical 15% settlement-company fee equals approximately $5,170.
The Ugly
Creditors are not required to cooperate. Jane can face collection lawsuits while waiting for settlements. A resulting judgment may permit garnishment or other remedies under applicable law, and forgiven debt can potentially create taxable income.
Debt Settlement Offers a Lower Number by Asking Jane to Accept More Risk
The appeal of debt settlement is easy to understand.
Jane's monthly deposit falls dramatically.
The company projects that she may repay only a fraction of the enrolled balance.
And the estimated three-year program is shorter than several other repayment strategies.
But Jane does not receive those benefits immediately.
She must first go through a period of delinquency while funds accumulate and creditors decide whether they are willing to negotiate.
Jane is essentially trading certainty for potential savings.
She receives no guarantee that every creditor will accept 40%. Meanwhile, her credit is damaged, collection efforts continue and the possibility of litigation remains.
Why Jane's Debt Settlement Result Looks Very Different From Her DMP
The previous Jane Doe case study showed a very different approach.
On the modeled Debt Management Plan, Jane repays the principal balance rather than asking creditors to forgive it.
In return, her participating creditors provide dramatically lower estimated interest rates and payments.
| Feature | Debt Management Plan | Debt Settlement |
|---|---|---|
| Jane's Monthly Amount | Approximately $692 | Approximately $535 estimated deposit |
| Estimated Time | 5 years | 36 months |
| Principal | Repaid in full | Company hopes to negotiate a reduction |
| Normal Creditor Payments | Continue through agency | Typically stopped while settlement money accumulates |
| Interest | Jane's modeled APR: 3.94% | Can continue accumulating while account remains unsettled |
| Credit Reporting | No strategy requires intentional delinquency | Missed payments and delinquency are generally part of the process |
| Lawsuit Risk | Accounts are being repaid under proposed creditor terms | Creditors may still sue while awaiting settlement |
| Forgiven Debt Tax Issue | No principal forgiveness | Canceled debt may be taxable unless an exclusion applies |
Debt settlement's lower projected monthly amount therefore comes with substantially more uncertainty and risk.
Before Choosing Debt Settlement, Compare Other Credit Card Debt Options
A projected settlement can look compelling when someone is struggling to make high credit card payments.
But the settlement percentage should never be evaluated by itself.
Consumers should also consider company fees, credit damage, delinquency, collection activity, creditor participation, lawsuit risk and possible taxes.
DebtWave Resources
- Compare Jane's previous Credit Counseling & Debt Management Plan case study .
- Use DebtWave's Debt Management Plan Calculator to compare current credit card terms with estimated DMP terms.
- Use the Credit Card Payoff Calculator to estimate the cost of paying cards under their current terms.
- Learn more about getting help with credit card debt .
How Does Debt Settlement Compare With Jane's Other Options?
We are evaluating the same Jane Doe financial situation using ten different approaches to dealing with $34,467 of credit card debt.
| Debt Relief Option to Pay Off Credit Card Debt | Grade |
|---|---|
| Personal Loan (Debt Consolidation Loan) | D+ |
| Credit Card Balance Transfer | C- |
| Withdrawing Money From a 401(k) | F |
| Taking a Loan From a 401(k) | D- |
| Credit Counseling & Debt Management Plan | A |
| Debt Settlement | D- |
| Credit Card Hardship Programs | B+ |
| Borrowing Money From a Friend or Family Member | D |
| Filing Chapter 7 Bankruptcy | D- |
| Filing Chapter 13 Bankruptcy | F |
The grades in this series are specific to Jane's hypothetical financial situation. A strategy receiving a low grade for Jane may be appropriate for a consumer facing very different financial circumstances.
Debt Settlement: D-
Debt settlement gives Jane two extremely attractive numbers: a projected payment near $535 per month and a potential 36-month timeframe.
If every creditor agreed to settle for approximately 40% of the balances, the amount paid directly toward settlements could be dramatically lower than the $34,467 Jane owes today.
But those numbers come with significant uncertainty.
Jane generally has to stop making normal payments to her creditors. Her accounts become delinquent and her credit profile can deteriorate significantly.
She may wait six months or longer before seeing the first settlement.
The hypothetical settlement-company fee adds another approximately $5,170 to the strategy.
Most importantly, creditors do not lose their collection rights simply because Jane enrolls with a settlement company.
They may refuse to settle.
They may continue collection activity.
They may sue.
And successfully forgiven balances can potentially create taxable income.
The lower projected repayment amount is attractive, but Jane is accepting substantially more credit, legal and tax risk to obtain it.
Overall Grade: D-
Should Jane Use Debt Settlement?
For Jane, debt settlement offers the possibility of repaying considerably less than the full $34,467 balance.
Her proposed monthly deposit of approximately $535 is also substantially lower than her current credit card payments.
But the projected savings should not be confused with a guaranteed outcome.
Jane's creditors are not required to settle for 40% — or settle at all.
Meanwhile, Jane is allowing her accounts to become delinquent while she waits for enough money to accumulate.
That exposes her to credit damage, additional interest and fees, collection activity, lawsuits and possible tax consequences if balances are eventually forgiven.
For Jane's specific financial situation, the risks outweigh the appealing monthly-payment and settlement projections.
Important: Jane Doe is a hypothetical case-study name used for educational purposes. Financial figures are based on a sample financial analysis with certain facts adjusted for this series. The 40% settlement estimate, $535 monthly deposit, 15% settlement-company fee and 36-month program are hypothetical assumptions and are not guarantees of actual settlement results. Creditors are not required to settle debts or accept a particular percentage. Stopping payments can result in late fees, additional interest, negative credit reporting, collection activity and lawsuits. Canceled debt may be taxable unless an IRS exception or exclusion applies. Consumers considering settlement should review the contract, fees and legal and tax consequences carefully.