Debt settlement usually refers to the act of settling a debt you own with one lump sum payment that is less that the balance you actually owe at the time. Sometimes, you can arrange a settlement paid out in several large payments. Debt settlement can be a way to handle an outstanding balance while saving yourself some money, but it's also tricky and doesn't always work.
If you can get a creditor to agree to a settlement and you can pay the amount the creditor wants, then you can save money in interest and long-term payments. Why would a lender agree to let you pay less than you owe? In some cases, the creditor still makes money. The balances on unsecured credit card loans, for example, are filled with additions such as fees, finance charges, and interest. If you owe $4,000, you might only have original spend $2,500. The creditor might be willing to settle for $2,900.
The fact that you settled your debt for less than original owed will show up on your credit report. That means future creditors can see that you didn't pay the full amount, and that could impact your ability to receive credit. You might also end up owing some tax on the amount of debt that was forgiven, as the Internal Revenue Service sees that as a form of income.
Finally, if debt settlement isn't handled in an aggressive, appropriate manner, it can backfire. You might make the payment, and the creditor might fail to live up to the agreement. Working with a legal professional to negotiate repayment plans or consider options such as bankruptcy to deal with debt can be a safer alternative.
Source: Bankrate.com, "Is debt settlement a good idea?," Leslie McFadden, accessed May 18, 2016