Debt Consolidation vs Debt Settlement

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If your debt has reached a crisis point where you’re paying what you can afford but not making progress in reducing the debt, you’re right to be concerned.

You’ve likely heard of two solutions — debt consolidation or debt settlement — and you may think they’re interchangeable terms. They’re not.

Debt consolidation and debt settlement are strategies for making debt manageable, but they are different methods and bring different results. Debt consolidation reduces the number of creditors you’ll owe and amount of your monthly payment. Debt settlement tries to reduce the amount of debt you owe.

The latter may sound preferable, but the best method for you will depend on your financial background and long-term goals.

What Is Debt Consolidation?

Debt consolidation combines multiple debts into a single payment. The four common ways to approach this are:

  • Debt management: A nonprofit credit counseling agency works with your credit card companies to reduce the interest rate charged and arrive at an affordable monthly payment that eliminates the debt in 3-5 years.
  • Zero-percent balance transfer credit card: Transfer your current credit card balance to a card that charges 0% interest. These are usually available only to consumers with credit scores above 680 and can involve a transfer fee of 2%-3% of the balance transferred. The 0% interest rate usually lasts 12-18 months, so you must be disciplined about paying off the debt in that timeframe. If you have trouble qualifying, you will need to look into debt consolidation options for bad credit.
  • Personal loans: Banks, credit unions, and online debt consolidation lending companies offer personal loans at fixed rates lower than credit cards. These loans also include an origination fee and can require collateral such as your home or car to secure the loan.
  • Home equity: Home equity lines of credit (HELOCs) and home equity loans also carry relatively low interest rates, but your home serves as collateral and could be lost if you fail to make payments. Application fees and closing costs can be involved.

Advantages of a Debt Consolidation Loan

Debt consolidation can make your life easier and less expensive. Simply having one payment to keep track of instead of several can be worth consolidating for some borrowers. A more considerable benefit is a lower interest rate in the debt management program or consolidation loan, which means you pay less every month. If you make on-time payments, debt consolidation will lower your credit score briefly, but the score will come back and be higher by the time you finish paying off the debt.

Disadvantages of Consolidating Debt

Debt consolidation is not a magic bullet. Reducing the monthly payments through consolidation can tempt you to take on more debt, which is what got you in trouble in the first place. If you don’t increase your payments and control your spending, the problem will continue. Also, consolidation loans may extend the payment period, which means it might take longer to pay off the debt, and you will pay more interest over the life of the loan.

» Learn More: Advantages and Disadvantages of Debt Consolidation

What Is Debt Settlement?

Debt settlement is a negotiation to get creditors to settle for less than what you owe. It usually requires a lump-sum payment of an agreed-upon amount. Some debt settlement companies may allow you to set up a structured payment plan, but most funds are usually due upfront.

Understand going in: Creditors aren’t obligated to negotiate or accept a debt settlement offer. But, if a creditor thinks your offer is the best chance to get at least some of the debt paid, a settlement is a possibility. Usually, to qualify for debt settlement, borrowers must demonstrate a genuine financial hardship that makes it difficult to continue making regular payments on their debts.

You can settle debt on your own without the assistance of a debt settlement company. Debt settlement is a negotiation process where you, or someone representing you, negotiates directly with your creditors to reach an agreement to settle your debt for less than you owe.

Advantages of Debt Settlement

The advantages of debt settlement sound almost too good to be true. The settled debt is gone, often for far less money than you owed. Debt settlement can relieve the stress and anxiety associated with mounting financial obligations. It can help you regain control of your finances and avoid bankruptcy.

Disadvantages of Debt Settlement

It should come as no surprise that debt settlement does terrible things to your credit score, knocking anywhere from 75-150 points off it. How could it not? If you can get future loans, they will come with high-interest rates.

» Learn More: How Does Debt Settlement Affect your Credit?

Then, there are fees. Assuming you aren’t making payments to creditors while negotiating a settlement, the late fees, interest, and penalties continue, adding to what you already owe. Debt settlements take time; 2-3 years is normal, which is a lot of late fees and penalties. Also, debt settlement companies charge a fee to negotiate for you, typically 20-25% of the final settlement.

Finally, the IRS may consider the amount of forgiven debt as income on which you will pay taxes.

Which Option Should You Choose for Managing Debt?

Debt consolidation is generally considered a less damaging option for your credit. It may be a better choice for those with good credit who can qualify for a lower interest rate. Debt settlement is more suitable for individuals who are in severe financial distress and have the means to negotiate lump-sum settlements with their creditors.

It’s essential to carefully research and weigh the pros and cons of each option and, if needed, consult with a nonprofit credit counselor to determine the best approach for your unique circumstances.

Things to ConsiderDebt ConsolidationDebt Settlement
How it worksCombining Debts: Debt consolidation involves taking out a new loan or credit account to pay off multiple existing debts, consolidating them into a single monthly payment.Negotiation: In a debt settlement program, you work with a debt settlement company or negotiate directly with your creditors to settle your debts for less than the full amount you owe. Creditors may agree to accept a lump-sum payment, but they are not required to accept any offer you make.
Credit Score ImpactWhile consolidating debt can temporarily impact your credit score due to a credit inquiry and the new account, it generally has a less severe and shorter-lived impact than debt settlement. Your credit history remains intact, and as you make on-time payments on the consolidated loan, your score will improve over time.Debt settlement will harm your credit score because you’re not paying the full amount you owe. The settled accounts are often marked as “settled” or “charged off,” which remains on your credit report for seven years.
Tax ImplicationsUnlike debt settlement, debt consolidation does not result in taxable income.The IRS may consider forgiven debt above $600 as taxable income.
FeesDebt settlement companies typically charge fees for their services, which can be substantial. Ensure you understand the fee structure and that it makes financial sense for your situation.Fees can vary depending on how you consolidate your debt. Debt consolidation loan interest rates range from 6%-36%.

When You Should Choose Debt Consolidation

Debt consolidation can be a sound financial strategy in certain situations, but it may not be the right choice for everyone. Here are some circumstances in which you should consider debt consolidation:

  1. High-Interest Debt: If you have multiple high-interest debts, such as credit card balances or personal loans, consolidating them into a single, lower-interest loan can save you money on interest payments over time.
  2. Simplifying Finances: Managing multiple debt payments each month can be challenging and overwhelming. Debt consolidation can make it easier to keep track of your finances by combining numerous debts into one monthly payment.
  3. Improved Interest Rate: If you can qualify for a debt consolidation loan with a lower interest rate than your existing debts, you can reduce the total amount you’ll pay over time, making it a financially beneficial move.

Debt consolidation can be a helpful tool to manage and pay off your debts more effectively, but it should be considered as part of a broader financial strategy. It’s essential to evaluate your financial situation, consider your goals, and carefully assess the terms and costs of any consolidation option before deciding.

How to Know If You Should Choose Debt Settlement

Deciding whether debt settlement is the right choice for your financial situation means evaluating your circumstances and considering the potential risks and benefits. Here are steps to help you determine if debt settlement is a suitable option for you:

  1. Assess Your Financial Situation: Take a close look at your financial status, including your income, expenses, and the total amount of debt you owe. Evaluate whether you are experiencing genuine financial hardship, such as a job loss, reduction in income, medical bills, or other significant life changes that make it challenging to meet your debt obligations. If not, you might solve the problem by creating and following a budget.
  2. Understand the Types of Debts: Determine the types of debts you are dealing with. Debt settlement is typically more appropriate for unsecured debts, like credit card debt, personal loans, and medical bills. Secured debts, such as mortgages and auto loans, are generally not eligible for debt settlement because the collateral can be repossessed or foreclosed upon.
  3. Consider the Consequences: Understand the potential consequences of debt settlement, such as a negative impact on your credit score and the possibility of having forgiven debt treated as taxable income by the IRS.

What to Look for in a Debt Consolidation or Debt Settlement Company

When considering a debt settlement or debt consolidation company to help manage your debts, it’s essential to exercise caution and thoroughly research your options. Here’s what to look for in a debt consolidation or debt settlement company:


Look for credit counseling agencies accredited by reputable organizations such as the National Foundation for Credit Counseling (NFCC) or the Financial Counseling Association of America (FCAA). Accreditation indicates adherence to ethical and professional standards.

For debt settlement, look for companies certified by organizations like the American Fair Credit Council (AFCC) or the International Association of Professional Debt Arbitrators (IAPDA). These organizations establish ethical standards for the debt settlement industry.

Nonprofit Status

While not all reputable credit counseling agencies are nonprofit, many are. Nonprofit status may indicate a focus on helping consumers rather than generating profits.

Free Initial Counseling

A trustworthy credit counseling agency should provide a free initial counseling session to assess your financial situation and discuss potential solutions.


The agency or company should be transparent about its services. Ensure you understand the cost structure and that there are no hidden fees. This is the case for both debt consolidation and debt settlement companies. Be cautious of companies that promise “guaranteed” results or don’t provide clear information.

Positive Reputation

Check customer reviews and ratings from reliable sources like the Better Business Bureau (BBB) and independent review websites. Positive feedback from previous clients can be a good sign.

Education and Support

A reputable agency should provide financial education and ongoing support to help you manage your finances better and avoid future debt problems.

It’s essential to thoroughly evaluate any debt consolidation or debt settlement company you consider working with. Be sure to conduct due diligence, ask questions, and carefully review all terms and agreements before deciding.

About The Author

George Morris

In his 40-plus-year newspaper career, George Morris has written about just about everything -- Super Bowls, evangelists, World War II veterans and ordinary people with extraordinary tales. His work has received multiple honors from the Society of Professional Journalists, the Louisiana-Mississippi Associated Press and the Louisiana Press Association. He avoids debt when he can and pays it off quickly when he can't, and he's only too happy to suggest how you might do the same.


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