Debt settlement vs. credit counseling: similar aims, different means

By Gary Foreman

The New Frugal You
New Frugal You columnist Gary Foreman
Gary Foreman is a former financial planner who currently edits The Dollar Stretcher website and newsletters. He writes "New Frugal You," a weekly Q&A column about frugal living, for

Ask a question.

'New Frugal You' archive

Question for the expert

Dear New Frugal You,
I hear an advertisement on the radio about calling a toll  free number to talk about cutting credit card debt in half. Is there a possible  way to have one-half of a $5,500 credit card debt forgiven? -- Joan

Answer for the expertDear Joan,
Most of us have heard them -- ads encouraging us to call them and have our debt reduced. Most of us have wondered, "How can that possibly be true?" Let's take a look at those ads.

Typically there are two types of firms that have similar ads -- credit counseling agencies and debt settlement firms -- but they offer very different services. 

A credit counselor will contact your credit card companies and work out a payment plan for you. Typically, a credit counselor will negotiate with lenders to reduce penalty fees and interest rates for you, but the amount owed will not be reduced. The lower interest rate and elimination of penalties can significantly reduce the amount it will cost you to repay the debt.

The standard tool in a credit counselor's bag is the debt management plan. These plans call for you to repay your entire debt over a period of years. Entering a plan won't affect your credit score. Legitimate credit counseling agencies are typically nonprofits accredited by either the National Foundation for Credit Counseling or the Association of Independent Consumer Credit Counseling Agencies and charge low fees, with a free initial analysis. 

Debt settlement is different. A debt settlement firm will attempt to get lenders agree to reduce the balance owed. Generally that reduced balance is paid at the time of the agreement and will be regarded as payment in full.

Creditors typically agree to settle debts in hardship cases or to people that the credit card company doesn't expect to be able to repay their debts. Often the borrower is already late in making payments. Creditors are not obligated to negotiate a settlement. So there's no guarantee that you'll get one.

Debt settlement companies are generally organized as for-profit businesses, and will want to be paid for their efforts. Typically they'll charge a percentage of the amount owed or the amount that they negotiate away. Their most-common tactic is to stop all payments to creditors in an effort to compel them to negotiate a lower debt.

Not all are honest. The settlement industry earned itself a bad reputation by running misleading ads, charging hefty upfront fees and then not delivering results, which left consumers in a worse position than ever. The U.S. Government Accountability Office outlined the problems in a 2010 study titled, "Debt Settlement: Fraudulent, Abusive and Deceptive Practices Pose Risk to Consumers." The abuses by the industry were pervasive enough for the Federal Trade Commission to crack down by banning upfront fees for debt settlement services 

You can negotiate with the credit card company yourself. You do not need a firm to do it for you. But it will require some research and effort on your part to work through the process.

Even if you're successful in negotiating a settlement, you'll also succeed at something you don't want: trashing your credit. Debt settlement lowers credit scores, dramatically. Those who start with excellent credit will lose it, as debt settlement lowers credit scores by 105 to 125 points, according to the credit scoring company FICO. For those with fair credit, the damage is lower, but still substantial -- 45 to 65 points. Debt settlement is second only to bankruptcy in the amount of score damage it will cause.   

The negative information on the settlement will remain on your report for seven years. But the effect will be gradually reduced if you make all your other future payments on time.

So what should you do? You don't say whether you're behind in your payments so we'll assume the best that you are not. Just having a bit of a struggle to keep up with them.

If that's the case you probably should forget the ads. Even if you had the money for a debt settlement, the hit to your credit score would be significant. And credit counseling is typically for people with a balance of $10,000 or more.

A better plan would be to contact your lender and ask for a lower interest rate. If you've been good about making your payments they may accommodate you.

If they don't, look for a balance transfer card with a low-rate introductory period. Look for the card with the longest intro period and the lowest fees. As with other credit cards, the best balance transfer cards deals go to the people with the best credit.

After you've made the transfer don't just pay the new minimum. Continue to pay your old, higher minimum. You'll end up reducing the amount of interest you pay. In effect, you're doing much of what a credit counselor could do.

See related: Budgeting for debt repayment, 2014 balance transfer card survey: Beware combo deals, two-tier fees

Meet's reader Q&A experts

Does a personal finance problem have you worried? Monday through Saturday,'s Q&A experts answer questions from readers. Ask a question, or click on any expert to see their previous answers.

Published: May 17, 2014

Join the discussion
We encourage an active and insightful conversation among our users. Please help us keep our community civil and respectful. For your safety, do not disclose confidential or personal information such as bank account numbers or social security numbers. Anything you post may be disclosed, published, transmitted or reused.

If you are commenting using a Facebook account, your profile information may be displayed with your comment depending on your privacy settings. By leaving the 'Post to Facebook' box selected, your comment will be published to your Facebook profile in addition to the space below.

The editorial content on is not sponsored by any bank or credit card issuer. The journalists in the editorial department are separate from the company's business operations. The comments posted below are not provided, reviewed or approved by any company mentioned in our editorial content. Additionally, any companies mentioned in the content do not assume responsibility to ensure that all posts and/or questions are answered.

Follow Us

Updated: 10-25-2016

Weekly newsletter
Get the latest news, advice, articles and tips delivered to your inbox. It's FREE.