Credit counseling vs. debt settlement: What to know to start your debt payoff

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Credit counseling sets you up with a debt management plan that consolidates your payments and may lower your interest rate or monthly payment, but it typically doesn't reduce how much debt you actually owe.

Debt settlement aims to negotiate down the amount you owe, but it carries more risk. Creditors may refuse to negotiate, you're often told to stop paying during negotiations (which can hurt your credit), and there's no guarantee of success.

Here's what to know about the cost, process, and potential long-term effects of each strategy so you can make the right choice for your debt payoff.

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What's the difference between credit counseling and debt settlement?

Lower interest and create a manageable repayment plan

You make one monthly payment to the agency, which distributes funds to creditors (often at reduced interest rates)

You stop paying creditors while the settlement company tries to negotiate a lump-sum payoff that's less than you owe

Repay the full principal, often with reduced interest or fees

Repay less than the full balance if settlement is successful

May lower your score temporarily, but less severe than default

Can significantly damage credit due to missed payments

Higher risk; no guarantee creditors will settle

Borrowers who can afford payments but need lower interest rates

Borrowers already behind and unable to repay debts in full

When you work with a nonprofit credit counseling organization, you'll typically have a meeting to discuss your financial situation so the counselor can determine if a debt management plan is right for you.

If you opt into a debt management plan, the counselor works with your lenders on different options for repaying your debt, which may include lower interest rates, a lower monthly payment, or a longer repayment period. Credit counseling doesn't typically reduce the amount of debt you owe, but it can make it easier to repay by making your monthly payment more affordable.

Debt settlement companies , on the other hand, may reduce your debt balances through negotiations with your creditors. You'll usually stop making payments on your debt, and instead start saving money for a settlement fund.

If negotiations are successful, you'll pay a lump-sum amount to the creditor for less than what you owe. Any remaining debt will be forgiven and the account will be closed.

It's important to know that not all lenders will work with debt settlement companies, and there's no guarantee the company can successfully lower your debt. There's also a serious risk to your credit, which will be damaged if you stop making debt payments.

Credit counseling typically costs less than debt settlement, but you're expected to repay the full amount you owe.

Your first session with a credit counselor is often free. The organization may also offer free financial education materials and tools.

But you should expect some fees when you enroll in a debt management plan through credit counseling. For example, you may pay a one-time fee when you start and then a flat monthly fee thereafter. You may qualify for fee waivers depending on your income and other factors.

For debt settlement, you'll typically pay a percentage rather than a flat fee. The company may ask for a portion of the overall debt you enroll or the amount of debt that the company resolves. These fees often range from 15% to 25%.

Watch out for any debt settlement company that asks for an up-front payment, though. According to the Consumer Financial Protection Bureau , each of the following things must happen before a debt settlement company asks you to pay:

The company reaches a settlement or otherwise successfully negotiates with your creditor.

You agree to the terms with the creditor.

You make at least one payment to your creditor or lender under the new terms negotiated by the debt settlement company.

How do you repay debt with each strategy?

Credit counseling: You make one consolidated monthly payment that the counselor distributes to your creditors. Debt settlement: You instead deposit payments into a separate account until the company negotiates a lump-sum settlement.

Credit counseling: You make one consolidated monthly payment that the counselor distributes to your creditors.

Debt settlement: You instead deposit payments into a separate account until the company negotiates a lump-sum settlement.

When you take on a debt management plan with a credit counseling service, you'll make a monthly payment to the credit counselor, and they'll pass on the payment that's owed to each of your creditors. This can help you consolidate your debt into a single monthly payment that's easier to track.

With debt settlement, you're encouraged to stop making payments to your lenders during the negotiation period. Instead, you'll contribute payments to a dedicated bank account. This account should be with a separate institution from the debt settlement company, and you can access it at any time.

Once the company reaches a settlement with your creditor or lender, they'll use the money in that account to pay off your debt in a lump sum. If the debt settlement company doesn't negotiate a settlement with your lender, you'll still be responsible for paying any late fees and interest accumulated throughout that period.

Credit counseling typically has a smaller impact on your credit than debt settlement.

If you have outstanding debt, it may already be affecting your credit. You can increase your credit utilization by spending close to your credit limit , and missed payments are reported to the credit bureaus and appear on your credit report. If your debts go to collections, they will also have a negative effect on your credit.

Because credit counseling often requires you to close your credit card accounts, your credit could take a temporary hit. But as you make payments toward your debt, building a positive payment history and lowering your credit utilization (since you won't be using your cards or opening more credit), you can build your score back up.

With debt settlement, the biggest risk is that the debt settlement company is unable to reach a settlement with your creditors. Throughout the negotiation process, you'll usually be asked to stop making monthly payments.

If there's no settlement later on, those missed payments can add up and result in negative information on your credit report, as well as a significant amount of late fees and penalties. Late payments and collections can remain on your credit report for seven years.

There are scammers posing as both credit counseling organizations and debt settlement companies. Often, bad actors make false promises about your debt payoff and ask you for money up front.

If you opt for credit counseling, make sure you choose a reputable, nonprofit organization. Two sites you can use to find credit counselors include the National Foundation for Credit Counseling (NFCC) and the Financial Counseling Association of America (FCAA) .

Always do your research on any debt settlement company before you agree to work with them, and look out for common red flags that a company may be scamming you, such as up-front fee charges, a guarantee to settle all of your debts, promising you can avoid any debt collections or lawsuits, and more.

Which is best: credit counseling or debt settlement?

Credit counseling and debt settlement both require long-term commitment to paying off your debt. A debt management plan or debt settlement negotiation can take years, and both require you to make consistent payments toward the balances you owe.

Credit counseling is a great starting point that can help you pay off your debt at lower fees and with less potential impact on your credit score. If you don't qualify for a balance transfer credit card or a debt consolidation loan , this is a good option to get help paying down your debt.

One of the biggest benefits of a debt management plan from a credit counseling service is getting more manageable monthly payments that can help you chip away at your total debt over time.

When you opt for credit counseling, make sure you're okay with closing your credit card accounts. You may also be unable to open new accounts for a set period under a debt management plan.

Debt settlement can be much riskier for your credit score and your wallet. If your creditors refuse to negotiate a settlement, you could be left with a long-term, negative credit score impact — and even more debt (plus fees and penalties) than you started with.

If you choose to work with a debt settlement company, make sure you're informed about exactly how much you'll owe and when. Be prepared for the possibility that you won't be able to settle all of your debt, even if the company successfully settles a portion.

An alternative to working with a third-party debt settlement company is reaching out to your creditors yourself. You may be able to negotiate a payment plan, waived fees, or even reduced payments without having to pay a debt settlement company's fees.

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