Debt settlement is negotiating with each creditor to pay off the loan balance at a much reduced level. Creditors realize that they may only receive 25% to 75% of the balance owed. However if the debtor defaults on the loan and declares bankruptcy the creditor would receive nothing. Creditors may not take the efforts of the debtor seriously enough to settle. Until the debt is settled by payment the creditor can proceed with legal action and with collection efforts.

There are consequences of debt settlement. The unpaid balance affects credit reports. The forgiven balance may be considered income and consequently taxes may have to be paid.

There are companies who provide debt settlement services on behalf of the debtors. These companies charge a fee, sometimes several thousand dollars.

A credit counseling program works with the debtor and negotiates with each creditor to reduce the balance, interest rate, and late fees. A new total monthly payment is established. The debtor pays the credit counseling service the new payment plus a fee for their services. The service subtracts their fee and the pays each creditor the agreed to amount.

Bankruptcy is a legal method of debt relief. The debtor declares that he or she is incapable of paying their debts. Unsecured debts may be discharged completely. Secured debts, such as a car loan or mortgage can be brought current over the time period of the court order, usually 3 to 5 years. The creditors have no choice but to accept the fact the debtor is no longer legally obligated to pay the debt. Bankruptcy can have a disastrous effect on the credit rating of the debtor, and the ability to obtain a home mortgage, new debt or car loan. In addition many employers routinely procure a credit report on potential employees and take that report into consideration during the hiring decision.