Debt Consolidation vs. Debt Restructuring: What's the Difference?

Debt consolidation vs. debt restructuring overview

Debt consolidation and debt restructuring can both make your debt easier to manage, but they solve the problem in different ways.

Debt consolidation rolls multiple debts into a single new loan that, ideally, has lower interest rates and more favorable terms.

Debt restructuring keeps your existing debt, but changes its terms through negotiations with your lender or creditors.

Here’s a side-by-side comparison of how the two differ.

Debt consolidation options and requirements

Debt consolidation typically makes the most sense if you have a solid credit score and can qualify for lower interest rates.

If you’re considering this option, here's what to know about the most common consolidation methods and their eligibility requirements.

Debt consolidation loans

A debt consolidation loan is essentially a personal loan that lets you combine multiple debts into a single monthly payment. Once you're approved, the lender either pays your creditors directly or deposits the money into your account so you can pay them yourself.

Debt consolidation loans are generally unsecured, which means they don't require collateral. But according to Equifax, one of the three major credit bureaus, you typically need a credit score of 740 or higher to receive the lowest interest rates.

To apply, lenders will generally ask for your:

• Proof of income
• Government-issued ID
• Employment information
• A list of debts you want to consolidate

» MORE: Best debt consolidation loan companies

Balance transfer credit cards

Another way to consolidate your debt is to move your high-interest balances to a balance transfer credit card. Many cards offer a 0% introductory APR on balance transfers for a promotional period, which allows you to save money on interest charges.

However, most cards charge a balance transfer fee of 3% to 5% of the transferred amount. So, if you’re transferring a $5,000 balance, it could cost you an extra $150 to $250. Make sure to factor transfer fees into your savings.

Another risk of this method is that if you don’t pay off your balance by the end of the promotional period, any remaining amount will start accruing interest at the card's regular rate.

You can request a lower APR after the introductory rate ends — prepare your credit info, be persistent, and explore promo rates in addition to balance transfers.

Home equity and secured options

If you own a home, you may be able to consolidate debt using a home equity loan or home equity line of credit (HELOC). Since these loans use your home as collateral, they often offer lower interest rates than unsecured personal loans.

However, home equity loans and HELOCs are riskier for you as the borrower because if you can't make payments, the lender could foreclose on your home. For that reason, these types of secured loans make the most sense if you have a stable income and can repay the debt.

Credit score and income requirements

Lenders consider many factors when they’re reviewing an application, but your credit score is typically one of the biggest determinants of the rates and terms you'll qualify for.

Here’s how your credit score can impact your options:

• 740 and higher: Typically qualifies for the lowest interest rates
• 670 to 739: Often eligible for competitive personal loans and many balance transfer cards
• 580 to 669: May qualify for consolidation loans, though rates are generally higher
• Below 580: Qualification becomes more difficult, but debt restructuring or credit counseling are still available options

Note that lenders will also look at your income, employment history and debt-to-income ratio to decide if you can comfortably repay a new loan.

Debt restructuring options and negotiation steps

Instead of replacing your existing debt with a new loan under debt consolidation, debt restructuring makes your existing debt more affordable.

Here are a few debt restructuring options to consider if you’re struggling to repay your debt.

Hardship programs and forbearance

Many creditors offer hardship assistance if you've experienced a job loss, medical emergency, natural disaster or other financial setback.

These programs may include:

• Temporary payment reductions
• Payment deferrals
• Reduced interest rates
• Forbearance, which temporarily pauses or reduces payments

Loan modification and new terms

If your financial difficulties are expected to last longer, your lender may agree to modify your loan permanently.

Depending on the creditor, a loan modification may include:

• Lowering your interest rate
• Extending the repayment term
• Reducing your monthly payment
• Moving missed payments to the end of the loan

Unlike consolidation, loan modification doesn't require taking out a new loan or qualifying based on your credit score.

Debt settlement and principal reduction

Debt settlement is another form of restructuring in which you negotiate to pay less than the full amount you owe. This option is generally reserved for borrowers who have fallen significantly behind on payments and can't realistically repay their debt.

You can negotiate directly with your creditors or hire a debt settlement company to negotiate on your behalf. Keep in mind that settlement can significantly damage your credit, so this should be your last resort.

A debt settlement can result in a credit score drop of around 100 for most people, according to InCharge Debt Solutions. However, the actual amount can vary based on factors such as your credit history, your current FICO score and the amount of debt settled.

» COMPARE: Pros and cons of debt restructuring

How to request debt restructuring

Follow these steps to request debt restructuring from your lender:

1. Contact your lenders as soon as you’re struggling to make payments.
2. Ask whether your lender offers hardship assistance or other restructuring programs.
3. Gather documents that demonstrate your financial hardship and current income.
4. Explain your situation to your lender and discuss repayment options.
5. Review any proposed changes before agreeing to new terms.
6. Continue making payments if possible until a new agreement is finalized.
7. Get the final agreement in writing and keep copies of all documents.

Documents creditors may require

Your lender may ask for the following documentation when you request hardship assistance or a loan modification:

• Recent pay stubs or proof of income
• Bank statements
• Tax returns
• Monthly budget or list of living expenses
• A hardship letter explaining your financial situation
• Medical bills, unemployment records or other documents supporting your hardship

How to choose between consolidation and restructuring

“Here's a simple gut check that works pretty well. Ask yourself if you could pay this off in five years if you just got a better interest rate? If you can, consolidate. But if the numbers still don't add up no matter what because the balance itself is just too big for what you earn, then restructure,” explained certified financial planner (CFP) Andrew Latham.

In other words, if you can still afford your monthly payments but want to lower your interest rate or speed up your repayment timeline, debt consolidation can make financial sense. But if you can't keep up with your current payments at all and are struggling financially, you may want to go with debt restructuring.

If you’re still on the fence about which one to choose, here are some questions to think through before making a decision:

• Can you qualify for new credit? If you have a pretty solid credit score and a stable income, debt consolidation could help you qualify for lower rates or better repayment terms.
• Can you afford your current payments? If not, restructuring may be a better choice.
• How many debts do you have? Consolidation works well if you have multiple credit cards or loans, whereas restructuring is better for one or more accounts that have become difficult to manage.
• How close are you to being in default? If you're already missing payments or facing collections, restructuring typically makes more sense than applying for a new loan.
• What's the total cost? Don’t just compare monthly payments. Also take into account APRs, fees and the total amount you'll repay over time.
• How important is your credit score? Consolidation typically damages your credit less than restructuring or debt settlement.
• What are your long-term financial goals? If you're planning to buy a home or apply for other financing soon, consolidating rather than restructuring can help prevent your credit score from dropping too much.

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