Debt Settlement Companies: What They Are and Why They Matter to Lenders

2nd Order Solutions
8 min readMay 7, 2024

Authors: Reese Quillian, Justin Metacarpa, Dave Wasik

Consumer debt has risen to record levels in recent years, with credit card debt alone surpassing $1 trillion in 2023. Rising delinquency rates reflect that consumers are struggling to keep up with these rising balances. As consumers weigh their options to get out of credit card debt, an increasing number of consumers see Debt Settlement Companies (DSCs) as an attractive option due to convenience and potential for cost savings.

DSC enrollment volumes are increasing and shifting towards earlier stages of delinquency. In fact, a significant percentage of DSC enrollments are from customers who are either current on their payments or less than 30 days delinquent. This has huge implications for lenders, who are trying to manage down delinquency volumes while having a DSC act as an intermediary with many of their delinquent borrowers. This post will go over background information, industry context, and the importance of DSCs to lenders.

Introduction to DSCs

Debt settlement companies are organizations that negotiate with lenders to reach a settlement, which is an amount less than the total balance owed by the consumer. The service provided by DSCs is one of many options for consumers to get out of debt more quickly, but it comes at a cost of high fees paid to the DSC. While this is primarily debt from credit cards, DSCs also work with personal loans, medical bills, and some private student loans, among others. With the goal of eventually reaching a settlement on the enrolled balance, DSCs perform the following activities:

  • Offer consulting and referral services. Debt consultants employed by a DSC will discuss options with consumers after doing a soft credit pull to define a path forward.¹ It is common for DSCs to refer customers to credit counselors or debt consolidation lenders.
  • Provide their contact information. A DSC will either reach out to the lender directly or the consumer can change the contact information associated with their account to that of the DSC. This means that the DSC will field collections calls, which is an important part of their value proposition for consumers.
  • Negotiate with lenders. The timing of this varies by each individual and lender, but the DSC will begin reaching out to lenders to negotiate settlements when 1) the consumer has proven they have sufficient funds to settle, and 2) the DSC believes they can get a favorable rate from the lender.
  • Charge fees for services. DSCs are for-profit organizations and charge a commission (typically 15%-25%) on each debt that is settled.

¹Note: DSC advisors have an incentive to enroll consumers with a DSC, but if eligibility requirements are not met, they will recommend another service. Outside of a minimum debt threshold, eligibility requirements are ambiguous.

How it works

For the consumer, the settlement process through the services of a DSC is simple and outlined in the diagram below.

Figure 1: An overview of the process that occurs when a consumer enrolls in a settlement program with a DSC

There are a few important things to note when it comes to the settlement process:

  • DSCs can view the balances of the escrow account held by the consumer, but the account is in the control of the consumer alone (i.e., the DSC cannot withdraw or hold funds).
  • On average, the threshold for DSCs to begin negotiations is savings of 20–25% of a given debt balance.
  • The DSC may only collect a fee after the consumer has made at least one payment to the lender once a settlement has been reached.
  • Without a process to actively identify DSC enrolled customers, the lender may be alerted to a customer enrolling with a DSC through a Notice of Enrollment, which is sent by the DSC. Without a Notice of Enrollment, the lender may not realize a customer is enrolled until the DSC first contacts the lender to make a settlement offer.

The main way DSCs make money is through their fees, which are commissions on each settlement they reach. Some DSCs structure their fees as a percent of the debt reduced, but it is more common for them to be structured as a percentage of the balance enrolled in the program. Additional revenue streams for DSCs are less transparent but can include fees for servicing the customer’s escrow account and/or money earned through strategic partnerships with other lenders and affiliates.

DSC Customers

The typical DSC customer is in real financial distress. They skew towards subprime, have usually experienced a recent hardship, and are struggling to keep up with their monthly payments. On average, a DSC customer carries over $25,000 in debt across more than seven accounts. This population is drawn to the potential cost savings and convenience touted by the DSC but may not grasp the extent of the negative consequences resulting from charging off and settling their accounts. A summary of the pros and cons of enrolling with a DSC through the lens of the consumer is below:

Pros

  • Single monthly payment. Consumer only needs to focus on a single monthly payment that is lower than the sum of their minimum monthly payments on current cards and/or loans.
  • Avoid collections calls. When a consumer’s contact information is changed to that of the DSC, they no longer need to worry about incoming collections calls.
  • Cost savings. Settlements result in the consumer paying less than what is owed without having to declare bankruptcy. Note: These cost savings may not be incremental to what an issuer would offer.
  • Short timeline. Settlement programs can be a quicker solution for getting out of debt compared to continuing minimum payments, as most programs range from 24–48 months.
  • DSC handles all negotiations. The consumer does not have to do any of the negotiating with their lender, rather all of this is handled by the DSC. The only thing a consumer needs to do is approve the settlement at the end of the process.

Cons

  • Success is not guaranteed. No DSC can promise a certain savings percentage or dollar amount.
  • Negative impact on credit score. Each settlement will bring down the consumer’s credit score and will remain on their credit report for seven years.
  • Risk of higher total debt load. DSCs cannot stop interest and fees from accruing on the account while the consumer is not making payments. Combined with the fee owed to the DSC, the consumer runs the risk of coming out paying more than they would have without the DSC.
  • Potential for lawsuit. When the consumer stops making payments, their creditor can take legal action. Enrollment in a settlement program does not exempt consumers from this possibility.
  • Forgiven debt has tax implications. With a few exceptions, the IRS considers the forgiven amount as income, on which the consumer will be taxed.

Industry Dynamics

The debt settlement industry is not new. It first emerged in the early 2000s, boomed during the Great Recession and was mostly unchecked until 2010², when regulations were established to protect consumers from scams and bad actors. The rule change laid the foundation for the industry that we know today, and DSCs have exhibited staying power. Over the past decade, the debt settlement industry has experienced continued growth with consumer debt pushing higher and higher.

The debt settlement industry is comprised of over 200 companies but is dominated by a small number of them. Freedom Debt Relief, National Debt Relief, and JG Wentworth are three of the largest debt settlement companies: collectively, they have settled billions of dollars of debt for over 1.5 million clients over the past two decades. The American Association for Debt Resolution (AADR), previously American Fair Credit Council, is the government organization that accredits DSCs. There are currently 37 accredited members of the AADR, which are pictured below.

²Changes were made by the FTC to the Telemarketing Sales Rule, making it illegal for DSCs to charge consumers up-front fees.

Figure 2: The AADR-accredited debt settlement companies as of March 2024. Not pictured: members not offering settlement services

From the Lender’s Perspective

Historically, lenders have struggled to adapt to the presence of DSCs within the consumer finance ecosystem. There are a few reasons for this:

  • Invisibility. Consumers enrolled with a DSC are often invisible to the issuer. As there are no reporting requirements, early identification of who is enrolled is difficult. The lender may not become aware of DSC involvement until a settlement offer is made, which is often long after the consumer enrolled with the DSC.
  • Disengagement. Consumers enrolled in DSC programs are much more likely to be non-responsive / non-engaged. They are told to not make payments and therefore are more likely to roll forward in delinquency. By the time the consumer is identified as being enrolled in a settlement program, it may be too late to re-engage the consumer.
  • Early Enrollment. The shift of DSC enrolls towards when customers are current or early in delinquency can exacerbate lender’s blind spots to how deeply their portfolio is penetrated by DSCs. Additionally, the shift shortens the window for lenders to reach DSC-curious customers with alternative offers prior to enrollment.

Conclusion

Given the continued growth and staying power that DSCs have shown, lenders are looking for ways to optimize their strategies for interacting with DSCs to best help resolve a customer’s debt. Identification plays a big role in this optimization: lenders need to have a process in place to identify which customers are enrolled (or likely to enroll) in settlement programs.

From our work in this space, 2OS has found that there are three key populations to consider:

  1. Customers who have not yet enrolled but are considering enrolling and/or exhibit characteristics that suggest they are likely to enroll in the future.
  2. Customers who have recently enrolled.
  3. Customers who have been enrolled for some time but have not yet reached a settlement.

Interactions with each population will have different characteristics, as responsiveness, willingness to explore other options, etc. will vary. Knowledge of the preference and behaviors of each population can be leveraged by lenders to enhance their Collections function with optimized strategies for interacting with DSC-enrolled customers and DSCs themselves.

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2nd Order Solutions

A boutique credit advisory firm providing credit risk & data science consulting services from top 10 banks to fintech startups