Americans owed $1.26 trillion on their credit cards in the second quarter of 2026, according to the Federal Reserve Bank of New York, just shy of the record set at the end of 2025.
About 12.8% of those balances were at least 90 days behind on payments in early 2026, up from 7.6% in late 2022, as Benzinga reported when the latest figures came out in August.
That is the crowd most debt settlement ads are aimed at, and knowing how the process really works can save you thousands of dollars and years of credit damage.
How Does Debt Settlement Work?
Debt settlement is a deal in which a creditor, the company you owe money to, accepts a single payment smaller than your full balance and treats the account as closed.
It applies mostly to unsecured debt, meaning debt with no property attached that the lender can take back, such as credit cards, medical bills, and personal loans.
Settlement programs generally do not handle mortgages or car loans, because those lenders can simply repossess the house or car instead.
A creditor agrees to take less because a borrower who has stopped paying might end up paying nothing, and some money now can beat a long, expensive collection effort.
You can negotiate a settlement yourself or hire a debt settlement company to do it for a fee, and the process follows the same basic path either way.
The reason people consider it comes down to interest.
The average rate on credit card accounts that were charged interest was 22.15% in the Federal Reserve's most recent consumer credit data, which works out to about $2,200 a year on a $10,000 balance.
When minimum payments barely dent that interest, settlement offers a way to close accounts for less than you owe, though the discount comes with costs the ads rarely mention.
The Debt Settlement Process Step by Step
You Stop Paying Your Creditors
Most settlement companies tell you to stop making payments, because lenders rarely negotiate on accounts that are current.
That missed-payment stretch is what gives the negotiator leverage, and it is also where most of the damage to your credit happens.
You Build Savings in a Dedicated Account
Instead of paying your cards, you deposit a set amount each month into a dedicated account, a savings account at an insured bank that is held in your name.
Under Federal Trade Commission rules, you own that money and can withdraw it at any time without penalty.
Your Accounts Fall Into Default
After about six months of missed payments, a lender typically charges off the account, meaning it writes the debt off as a loss on its books and may sell it to a collection agency.
A charge-off does not erase what you owe, and you may end up negotiating with a debt collector instead of your original bank.
The Negotiator Makes an Offer
Once enough money builds up, the negotiator offers the creditor a lump sum and the two sides go back and forth until they agree on a number or the creditor refuses.
You Pay the Settlement and the Fee
When you approve a deal, money moves from your dedicated account to the creditor, and only then can the company collect its fee on that debt.
Get the agreement in writing first, showing the exact amount and stating that the payment resolves the entire balance.
Because savings build slowly and each debt is settled one at a time, a program covering several accounts often takes two to four years to finish.
What Debt Settlement Costs in Real Dollars
Imagine you owe $20,000 across three credit cards and enroll all of it in a settlement program.
While you save, you stop paying, so late fees and interest push the total to about $23,000 by the time negotiations wrap up.
The negotiator gets your creditors to accept 50% of that balance, so you pay $11,500.
Settlement companies commonly charge 15% to 25% of the debt you enroll, and a 20% fee on your original $20,000 adds $4,000.
The $11,500 your creditors forgave may also count as taxable income, and in the 12% federal tax bracket that adds about $1,380 to your tax bill.
Your all-in cost comes to roughly $16,880, which clears the debt but saves you closer to 15% than the 50% headline, though that comparison leaves out the interest you would have paid carrying the balance for years.
The Risks to Weigh Before You Enroll
Your Credit Score Takes a Serious Hit
Months of missed payments, a charge-off, and an account marked as settled for less than the full balance all drag your score down.
Most of that negative information can stay on your credit report for seven years, according to the Consumer Financial Protection Bureau, though its impact fades as it ages.
Creditors Can Sue You
Creditors are not required to negotiate, and some file a lawsuit while you are still saving.
If they win a court judgment, they may be able to garnish your wages, meaning take money straight out of your paycheck.
Forgiven Debt Can Be Taxed
The IRS generally treats canceled debt as income, and a creditor that forgives $600 or more typically sends you a Form 1099-C reporting it.
There is an exception if you were insolvent, meaning your total debts exceeded the value of everything you owned right before the settlement, which can let you exclude some or all of the forgiven amount by filing IRS Form 982.
You Could End Up Deeper in Debt
Some creditors refuse to work with settlement companies at all, and signing up does not stop collection calls or lawsuits.
People who drop out partway through can be left with lower credit scores and larger balances than when they started, a risk the CFPB warns about directly.
Other Ways Out of Credit Card Debt
Negotiating on Your Own
You can call your creditor or the collection agency and make the same lump-sum offer yourself, which skips the company's fee entirely.
It takes persistence and works best once you already have cash set aside to pay a deal on the spot.
A Debt Management Plan
A nonprofit credit counseling agency can set up a debt management plan, which rolls your card payments into one monthly payment, often at a lower interest rate, while you repay the full balance over three to five years.
Because you keep paying, it does far less damage to your credit than settlement.
A Debt Consolidation Loan
A consolidation loan pays off several cards with one fixed-rate loan, which only helps if your credit is still strong enough to qualify for a lower rate.
A common mix-up is treating consolidation and settlement as the same thing, and some companies advertise consolidation while actually selling settlement, so confirm which one you are signing up for.
Bankruptcy
Chapter 7 bankruptcy can wipe out most credit card debt within a few months, and debt erased in bankruptcy is not taxed as income.
The tradeoff is that a bankruptcy can stay on your credit report for up to 10 years, and some bankruptcy attorneys offer a free first consultation to walk through whether you qualify.
How to Spot a Trustworthy Settlement Company
Under the FTC's Telemarketing Sales Rule, a company that sells debt relief over the phone cannot charge you anything until it has settled at least one debt, you have approved that deal, and you have made at least one payment to the creditor.
A company that asks for money upfront is the clearest warning sign you will get.
The CFPB also flags companies that guarantee your debt will disappear, promise to stop all collection calls and lawsuits, or pitch a government program that will wipe out your credit card balances.
A settlement contract commits you to years of deposits and fees, so the fine print matters as much as the promised discount.
If you want a second set of eyes before signing, LegalShield connects you with a provider lawyer who can review contracts and advise on debt collection issues for a monthly membership fee, which can also help if a creditor sues partway through a program.
Once each settlement closes, pull your free credit reports at AnnualCreditReport.com and confirm the account shows a zero balance, since a settled debt that still reports as owed can hold your score down long after you have paid it.
