What is the difference between personal debt reduction and personal debt settlement?

The difference can be found in the difference in meaning between “reduction” and “settlement.” Personal debt reduction lowers the amount owed. This is something that can be negotiated with the creditors, and they may agree to reduce debt if it’s clear you can’t pay the full amount—the theory is, better to get something than nothing. However, while the amount you owe is reduced, you are still in debt and still making payment. This can most clearly be seen in some of the programs to help mortgage borrowers in danger of default—the bank or lender (often with prodding or incentives from the government) reduces the principal balance owed to make it possible for the borrower to stay on top of their debt.

Note that companies don’t like to do this—who would; you’re giving up money you’re owed—so it’s far from a given that you can negotiate a reduction. It’s worth trying if you’re in trouble, though.

In personal debt settlement, you offer to pay off the debt in full now for some fraction of its remaining value. Obviously, the more of the outstanding principal you could pay, the more favorably your proposal will be received. You don’t merely reduce the debt, you settle it completely—in exchange for $X, the creditor releases you from the debt. Again, the idea is that the creditor guarantees getting some of the money, and gets it faster, which is why it’s willing to write down part of the debt.

Be wary of commercial debt settlement companies. They often charge high fees for their services, and also often work by putting your money aside without paying the creditors, building up a sufficient balance over time to make a settlement offer. But because there is no law or rule allowing you to withhold payments to accumulate a balance for a settlement, this can result in you being in default on your debt, resulting in damage to your credit rating and also potential lawsuits.

A lawyer with experience in helping debtors can be a good alternative to a debt settlement company: the attorney can negotiate with creditors, is bound by law to treat you ethically, and can explore other legal options, such as bankruptcy, that may be worth considering.

Also, note that being released from debt—having debt forgiven, whether by reduction or settlement—can constitute income according to the IRS. In other words, you may owe taxes on the amount you save.