Debt Consolidation Vs. Debt Settlement: Which Is Better?

Loans, Personal Loans, Unsecured Loans


Debt can be a powerful tool when you want to buy a home or a car or go to school. But sometimes debt stinks. Take away mortgage debt, student loan debt and auto loan debt and the U.S. still has over $1.3 trillion in debt from credit cards and other forms of debt.[1]

While we all want our debt to disappear, it’s not likely to happen any time soon. However, there are debt relief options to help make your debt more manageable with two popular options being debt consolidation and debt settlement.

But debt consolidation and debt settlement are not the same things. Debt consolidation involves taking out a new loan while debt settlement involves negotiating with your creditors. Both have different benefits and risks and are useful in different situations.

Want to know the difference between these debt-defying options? Read on to find out more.

What Is Debt Consolidation?

With debt consolidation you take out a loan and use it to pay off multiple debts, consolidating all your debt into a single monthly payment. It won’t lower the amount you owe, but if you can consolidate your debt at a lower interest rate and spread out your payments over a longer period, it can lead to a lower monthly payment. Also, by consolidating variable-rate debt into a fixed-rate loan, you gain some protection against possible future interest rate increases.

You can usually consolidate debt using one of these methods:

You can also use a balance transfer credit card offer with a low or 0% interest rate. Unfortunately, these offers usually only last for 6 – 18 months. Another option is to talk to your local credit union. They may be able to set you up with a new credit card with a lower interest rate that doesn’t expire.

What Is Debt Settlement?

With debt settlement, you or a representative works with your creditors to negotiate a better offer. Essentially you ask the creditor to settle for less in exchange for your consistent payments.

This process may require you to hold back on making payments to your creditors, this is risky, but a creditor may be willing to accept a settlement rather than have to put your debt into collections or sell it at a loss.

It’s usually better for your credit to pay a debt in full rather than use debt settlement. But if you want to try debt settlement you can do it in one of three ways:

Do it yourself

If you (or your lawyer) call your creditors and explain you’re having financial difficulties, they may be willing to negotiate a settlement. This may involve them giving you more time to make payments or agreeing to settle for a fixed amount and setting up a repayment schedule. In some cases, you may even be able to convince your creditors to forgive all or part of your debt.

For-profit debt settlement

Sometimes called debt relief companies, these are for-profit companies that offer to settle your debt for less than the full amount. They do this by collecting your monthly payments from you and not paying your creditors. After a few months, the debt settlement company offers to buy off your debt for less than it’s worth using the funds you set aside. 

Not All Debt is Created Equal

Debt consolidation or settlement is usually reserved for unsecured debts like credit cards, personal loans and medical debt.

Debt Consolidation vs Debt Settlement: What’s The Better Choice?

There are pros and cons to both debt consolidation and debt settlement. 

Fewer accounts to manage

Having to juggle fewer accounts every month can help you to stay on top of your payments. It also lowers the chance of you missing a payment which can hurt your credit.

Budget relief

Consolidating debt can help you to extend the time you have to pay off a debt. This can help give you the breathing room you need to get your budget back on track.

Potential savings

In addition to saving money on interest, consolidating may help you avoid the additional fees credit cards usually charge that can quickly add to your balance.

Improve your credit score

Credit rating agencies weigh different types of debt differently. If you can consolidate unsecured credit card debt with secured debt like a home equity loan, you may see a big boost to your credit score.

Upfront costs

While some debt consolidation loans can save you money in the long run, you may need to make an upfront payment for closing costs and origination fees on a home equity loan or for balance transfer fees on 0% interest credit cards.

Credit score

To qualify for many consolidation loans, you’ll need to have a credit score in the mid-to-high 600s. If your credit doesn’t meet the lender’s standards, they may not approve you or may charge you higher-than-average interest rates.

Repaying in full

While consolidating your debt into a new loan can help make it more affordable, it doesn’t cancel the debt.

Pay debt off quicker

A debt settlement plan can help you get out of debt in less time because you’re offering to make a lump sum payment to cover your debt. Once the payment is made, your debt is gone.

Potential savings 

The key appeal of debt settlement is the ability to settle a debt for less than you owe. Depending on the situation, you could wind up paying less than 50% of your debt.

Late fees

Because you aren’t making payments to your creditor, you can rack up late fees and other penalties that can add to your debt.

Credit damage

Even one late payment can stay on your credit report for up to 7 years.[2] Rack up multiple late payments and you could lower your credit score significantly.

Settlement fees 

For-profit debt settlement companies don’t offer their services for free. Some can charge as much as 20% – 25% of the final settlement amount. This can quickly negate any savings you may have gotten from settling your debt.

Creditors may deny you

While debt settlement companies claim they’ll be able to negotiate with your creditors, your creditors are under no obligation to settle your debt. If that happens, you’ll have wasted time and money and done significant damage to your credit.

Time commitment

While debt settlement can help you pay down debt in less time, it won’t happen overnight. Most debt settlement companies need to collect 2 – 3 years’ worth of monthly payments from you before they can settle your debt.

Scam risk 

Many debt settlement companies are legitimate, but there are plenty of scam artists who target people in debt, make similar claims, charge you a large upfront fee and then disappear. Even if the debt settlement company is legitimate, they may use high-pressure sales tactics or overpromise to get your business.

Legal issues 

While you’re not paying creditors, they are within their rights to use every legal option to collect from you. This can put you at the mercy of debt collectors, lawyers and other individuals who will stop at nothing to collect what you owe them.

Forgiven debt may be taxable

Even if your debt is canceled or discharged, you may still need to pay taxes on the difference between what you owed and what you ultimately paid your creditor.[3]

Debt Consolidation vs Debt Settlement: Which Is Right for You?

Choosing whether to take advantage of debt consolidation or debt settlement will depend on your credit, income and overall financial situation.

When debt consolidation makes sense

Having a lot of debt may not mean you’re in a bad place financially. If you have good credit, a stable income and feel you have a good handle on your finances, debt consolidation may be the way to go.

The key to successful debt consolidation is having a budget. Not only will it help ensure you have enough money to make your monthly consolidation payment, but it can also help you to get your footing so you won’t go into debt again. 

Working with a credit counselor or financial planner can help you to make the right move regarding a debt consolidation loan.

 When debt settlement makes sense

Debt settlement may be a better option if you’re having real trouble financially. If you can’t get a consolidation loan due to your credit score or you’re missing payments consistently, debt settlement may be a better option than needing to declare bankruptcy.

However, while it may be better than bankruptcy, it may not be the best solution for you. Before considering debt settlement, you may want to talk to a debt counselor or bankruptcy attorney to make sure you aren’t making the situation worse.

Nonprofit Debt Management

If you’re looking for a happy medium between debt settlement and debt consolidation, you may want to work with a credit counseling agency or debt management company. These are nonprofit organizations that can help you with budgeting and managing your finances. A credit counselor will work with you to create a debt management plan that may include better budgeting and financial education. 

They may also be able to help you settle debt with your creditors. Your credit counselor does this by contacting your creditors and negotiating a debt repayment plan on your behalf. Once they’ve done that, you send them a single payment each month to cover all your debts and they take responsibility for paying your creditors.

You can find nonprofit debt management companies in your area through the National Foundation for Credit Counseling or the Financial Counseling Association of America.

There’s Help for Debt

If you’re having trouble with debt, there are options available to you like debt consolidation, debt settlement and debt management. The most important thing to remember is that getting out of debt doesn’t happen overnight. It also needs to be done as a part of a larger financial plan.

Otherwise, you risk going even further into debt and making things worse.



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