Debt Settlement Companies: Risks, Fees and Red Flags

By Hamid Ali, Founder of DebtShift · Updated October 14, 2026 · United States

A friendly voice on the phone tells you to stop paying your credit cards.

Short answer: A debt settlement company says it can negotiate your debts down for a fee, usually by having you stop paying creditors and save into an account. It can work for some people, but it can also damage your credit, add penalty charges and fees, and leave you sued. Under the FTC rule, phone-based companies cannot collect a fee until they have settled a debt and you have made a payment under the deal.

The facts below come from the CFPB and the FTC. Read them before you sign anything.

Build my payoff plan

How the model works, and where it hurts

Settlement companies say they can renegotiate or change the terms of your debts. You can also negotiate directly with a creditor or collector yourself (CFPB).

Late fees and penalty interest build up while you stop paying, and collection efforts may increase (CFPB). Use the minimum payment trap calculator to see what interest does to your balance.
A creditor may sue you while you wait (CFPB).
The company may not settle everything, and penalties on unsettled debts can cancel out the savings on the ones it does settle (CFPB).
Some creditors may refuse to work with the company you chose (CFPB).
You may be told to use a dedicated account run by a third party, which can carry its own fees (CFPB).

The CFPB puts it plainly: settlement may leave you deeper in debt than you were when you started.

What the FTC fee rule says

Telemarketers selling debt relief by phone may not charge before they settle or reduce your unsecured debt. A fee is allowed only after the company has settled or changed the terms of at least one debt, you have agreed to the deal, and you have made at least one payment to the creditor under it (FTC). The rule took effect for people enrolling on or after October 27, 2010.

The FTC says a dedicated account can only be required if you own the money, can withdraw at any time without penalty, and the account is held at an insured institution and not run by or tied to the provider (FTC). The rule covers for-profit companies; it does not cover nonprofits.

Check my rights

Red flags from the CFPB

Charges fees before it settles your debts.
Promises to settle all your debt for a set percentage reduction.
Promotes a “new government program” to erase credit card debt.
Guarantees your debt will go away or can be paid for pennies on the dollar.
Tells you to stop communicating with your creditors.
Promises to stop all collection calls and lawsuits.

All six red flags are from the CFPB page linked above.

Before enrolling, the CFPB suggests asking about all fees and when they are due, whether you must stop paying creditors, which creditors the company will actually work with, where your money is held, and what happens to your credit and to lawsuits (CFPB).

Other routes first

Nonprofit credit counseling can build a debt management plan you can afford (CFPB). Compare it with consolidation and bankruptcy in settlement vs consolidation vs bankruptcy and Chapter 7 vs Chapter 13, and see how to pay off credit card debt.

See all my debt options

Before you panic, read these

Can they charge me before they settle anything?

For phone sales, no. The FTC rule bars a fee until the company has settled at least one debt, you have agreed to the deal, and you have made at least one payment under it (FTC). The CFPB lists any fee before settlement as a red flag (CFPB).

Do I have to stop paying my creditors?

Many programs ask you to. The CFPB says late fees, penalty interest and other charges then pile up and collection efforts may increase, and it flags companies that tell you to stop communicating with creditors (CFPB).

Can I still be sued?

Yes. A creditor may sue you while you are working with a settlement company (CFPB). See what to do if you are sued and your rights with collectors.

Will it hurt my credit?

It can. The CFPB says debt settlement can lower your credit scores and make it harder to get credit later (CFPB).

Is the forgiven amount taxable?

It may be. The CFPB says forgiven debt may count as taxable income on your federal return, so check with a tax professional (CFPB).

What are the alternatives?

The CFPB points to nonprofit credit counseling, negotiating with creditors yourself, or talking to a bankruptcy attorney (CFPB). Free counseling is available through the NFCC at 877-360-6322.

Disclaimer: DebtShift is an educational platform operated by H Ali Logistics Ltd. This article is general education, not legal or financial advice. For free, nonprofit credit counseling, contact the National Foundation for Credit Counseling (NFCC) at nfcc.org or 877-360-6322.

Sources

Last reviewed October 2026