Debt settlement, also known as debt arbitration, debt negotiation or credit settlement, is an approach to debt reduction in which the debtor and creditor agree on a reduced balance that will be regarded as payment in full. During a negotiation period, all payments by the debtor are made to the debt settlement company, which typically withholds payments to the creditors, even if the debtor has paid a lump sum or made payments. Once all the debtor's accounts are in default due to this non-payment, the debt settlement company has leverage to force the debtor to accept a reduced lump sum payment as settlement. The debtor's credit rating goes down significantly due to the default, especially if the debtor was not behind on payments before the negotiation period commenced. Even though the accounts are "settled," the default appears on the debtor's credit record for seven years. Nevertheless, some debtors prefer this method of debt reduction over bankruptcy.
Debt settlement is often confused with debt consolidation or debt management. In debt consolidation and debt management, the consumer makes monthly payments to the debt consolidator, who takes a fee and passes the rest on to the creditors; this way, creditors continue to receive payments each month. In debt settlement, the consumer makes monthly payments, out of which the debt settlement company takes its fees for the legal work or negotiation and payments are paid to the creditor. The debt settlement company may persuade the creditor to accept a settlement less than the amount the debtor pays, with the debt settlement company keeping the difference.