Debt settlement is generally done in cases where the borrower is facing extreme financial difficulties, where bankruptcy is very likely. A debt settlement firm helps the borrower negotiate with creditors to settle the debt for a lower amount than the borrowed amount and pays a lump sum amount to settle the debt.

Most third party debt settlement companies charge fees and it is not always apparent how much they charge so beware and read the agreement entirely and watch for hidden fees. However, you don't need to hire a professional to do this for you. Debt settlement has become so common and popular that many of the major credit card companies will offer settlements in order to cut their losses. Some settlements have been as high as 50% of the outstanding debt but the average is less than that. Using the do it yourself approach requires that you learn how to negotiate.

If you don't settle after a few months of delinquency, your account may be turned over to a collection agency or you could be sued by the creditor. A judgment resulting from a lawsuit will appear on your credit report and could stay there as long as 10 years. Debt settlement will not appear on your credit report. However, if you are already delinquent on your payments, then your credit may already be impaired.

The lenders agree to settle for a lower amount because if the borrower is unable to pay the loan, and declares bankruptcy, then the lender is at a greater risk of losing a larger amount of debt owned. However if the borrower does not show financial difficulties the lender might refuse to settle the debt in this manner and even take legal action against the borrower.

While debt settlement does get recorded on your credit report, it is usually considered less damaging to your credit than bankruptcy. The debt consolidation and debt settlement organizations might assist you in relieving you of but they cannot free you from debt completely.

Whether a borrower decides to settle dues directly with lenders or through professional debt settlement firms they will have to set aside a certain sum of money to build up a settlement fund. The settlement company will require a limited power of attorney to act on behalf of the borrower and negotiate with the lenders.

After collecting a certain amount of money the borrower will negotiate with the lender to agree with the reduced payment amount. Once the lender agrees to the settlement amount the payment is arranged for making a full and final settlement.

Monthly payments can be made into the settlement fund to pay off the debt amount agreed upon. The lender then sends a letter to the borrower and the credit bureaus stating that the amount has been settled for less than the agreed amount.

There are a few disadvantages. You must consider your credit report and tax consequences of debt settlement.