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Debt settlement vs. debt consolidation

Compare the pros and cons of both debt relief options

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by Barbara Friedberg Personal Finance Contributing Editor
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Difference between debt settlement and debt consolidation

Debt consolidation and debt settlement are both forms of debt relief. With debt consolidation, you transfer your debts into one master account, typically a personal loan or balance transfer credit card, which allows you to simplify how you make payments and often lengthen the repayment term to ease your debt burden while you work on paying your debts off.

In the case of debt settlement, you or a financial professional acting on your behalf negotiate your debts, convincing creditors to agree to accept a lower payment to settle your account. Unlike debt consolidation, which simply gives you more time to repay your debt, debt settlement lowers the total amount you owe.

Both debt settlement and debt consolidation are ways to manage debt that has become overwhelming. Each has different requirements and results, so compare to see which plan is best for you.

 Debt SettlementDebt Consolidation
Credit ScoreNo set requirementGenerally above 600
Debt TypeUnsecuredSecured or unsecured
Debt AmountMost require $7,500+ in debtMost require $5,000 in debt
Fees15–25% of enrolled debt8–29% APR
Best ForThose who are behind on their payments and cannot afford to pay their debtsThose with good credit and large debt who need a lower monthly payment
CompareBest Debt Settlement CompaniesBest Debt Consolidation Companies
 Credit ScoreDebt TypeDebt AmountFeesBest ForCompare
Debt SettlementNo set requirementUnsecuredMost require $7,500+ in debt15–25% of enrolled debtThose who are behind on their payments and cannot afford to pay their debtsBest Debt Settlement Companies
Debt ConsolidationGenerally above 600Secured or unsecuredMost require $5,000 in debt8–29% APRThose with good credit and large debt who need a lower monthly paymentBest Debt Consolidation Companies

Pros and cons of debt settlement

Debt settlement is when a creditor agrees to let you pay your balance for less than what you owe. It should be your last resort, if possible, because it will have a big impact on your credit report for seven years. Plus, you may not even come out on top, thanks to the fees and taxes that you’ll owe as a result of the settlement.

If possible, take a less drastic measure like seeking advice from a debt counselor about money and debt management plans as soon as you see early warning signs, like your income is too low to make your monthly payments or you’re borrowing from some creditors to pay others.

“When you reach that point, you need to get some advice on what options are there for you, whether it’s working on your budget, doing some kind of debt consolidation loan, free advice from a credit counselor, debt settlement or bankruptcy,” says Russell Graves, president of the Association of Credit Counseling Professionals.

Is it smart to settle debt?

If you’ve exhausted all other avenues and debt settlement is still your best option, most creditors are willing to negotiate a settlement with you.

Benefits of debt settlement

  • Lower your total debt: Once you’ve negotiated and your creditors have accepted a settlement, you can end up paying as little as half of what you initially owed (plus the cost of fees and interest accrued as you pay off your new balance).
  • One monthly payment: Enrolling in a debt settlement program turns your debt into one affordable monthly payment. Instead of keeping up with multiple accounts, you make your monthly payment to the debt settlement company, who will distribute the funds out to your accounts once a settlement has been accepted.
  • Stop dealing with creditors: Your debt settlement representative will negotiate with creditors on your behalf, which means less interaction with creditors, and hopefully less stress, for you. 

Is debt settlement bad?

The negative effects of choosing debt settlement outweigh the positives. Experts agree on these seven cons that you should be aware of before you start negotiations with your creditors:

Disadvantages of debt settlement

  • Credit report and credit score impact: When you settle a debt, your lender or collector reports the debt as “settled for less than agreed” or “settlement accepted,” which shows up on your credit reports for the next seven years.

    They also continue to report late payment status updates to each credit bureau until your debt is settled, which negatively affects your credit score. Having a poor credit score makes it harder for you to get a loan. And if you do get a loan, you’ll have a hard time getting a low-interest rate.

  • Time: Typically, a debt settlement plan takes about two to four years, which means 24 to 48 months of late fees and penalties added to your total amount owed.
  • Additional fees and costs: Even though you’re negotiating a lower balance with a debt settlement, you’ll still be racking up interest, lender fees (15 to 25 percent) and taxes on the amount you’re paying off.
  • Taxes: Keep in mind, the IRS views any forgiven debt as income. So you would pay taxes on the total forgiven amount. Make sure that after you calculate fees and taxes you’re not paying more to settle your debt than you actually owed in the first place.
  • Not a sure thing: Some lenders won’t work with debt settlement companies since they aren’t obligated to do so.


Compare the best settlement companies

Pros and cons of debt consolidation

Debt consolidation is a form of debt relief where people combine all debts into one single debt at a lower interest rate. The appeal of debt consolidation is the chance to reduce interest charges and possibly lengthen the loan term. Debt consolidation also simplifies credit management by combining many payments from various lenders into one.

Consolidating debt is a good way to get out of debt, but it may not be for everybody. First, research the basics of debt consolidation. There are advantages and also pitfalls that can lead to more debt.

Is it smart to consolidate debt?

If you’re having trouble with high monthly payments, high interest rates and too many due dates to manage, debt consolidation might be the solution. Combined with credit counseling or a debt repayment plan, debt consolidation can help you pay your debts in an organized manner, without the stress of managing multiple bills.

Benefits of debt consolidation

  • Convenience: Making a single payment a month takes one stress out of your life. You deal with just one lender and manage less paperwork, which can make it easier to budget for your payment. With just one loan to manage, you don’t have to deal with multiple creditors, multiple payments and multiple due dates.
  • Build cash savings: The goal of debt consolidation is to reduce your debts and help you save by using a debt consolidation solution with a lower interest rate. You could save on loan fees and charges if your existing loans levy monthly fees because you’ll have only a single loan instead of several.
  • Increase credit score: Debt consolidation solutions might negatively impact your credit score initially, but consistent and timely payments will help you recover lost points. Your credit score will also benefit if you retain your old credit cards whose balances have been paid off by consolidation. This reduces your debt utilization ratio, which is the amount of debt you have divided by your available credit limits. Credit rating agencies typically recommend a 30 percent or lower debt utilization ratio. Just remember to use your cards sparingly.
  • Enjoy low interest rates: Most consumer debts come from credit card bills that typically carry high interest rates. Debt consolidation companies can help you negotiate lower interest rates. This enables you to more quickly tackle the principal debt amount to reduce your liabilities sooner.
  • Get rid of collection calls: With late payments come collection calls. The more creditors you have, the more collection calls you receive. These calls can be stressful and annoying. With debt consolidation, you regain peace and can focus on improving your financial situation and paying off debt.

Is debt consolidation bad?

Debt consolidation may not be good for you if you want to get a quick fix on your debt troubles. You’re merely transferring multiple debts into one account or getting a new loan with an extended term to pay them all off. This means you’ll be in debt longer and you could get into more trouble if you miss making payments or rack up more debt.

Disadvantages of debt consolidation

  • You could pay more interest overall: While debt consolidation loans can give you lower interest rates, you could still be paying more interest over the life of the loan. If you opt for lower monthly payments, your lender might lengthen the life of your loan to spread out those payments, potentially costing you more overall in interest payments.
  • You could be subject to garnishment for non-payment: Any loan is risky. If you default on your credit card balance transfer account, personal loan or home equity loan, your creditors can file collection lawsuits against you. Depending on what the court decides, your paycheck, bank accounts, home, car and other assets can be garnished, foreclosed or auctioned.
  • Debt consolidation fees are expensive: Debt consolidation services don’t come free. Aside from the interest on your debt consolidation loan or credit card balance transfer, there are other fees to pay. Fee types and amounts vary from company to company.


Compare the best debt consolidation companies

LabelCompany nameLogoContactSummary
Best Debt Consolidation Get a Free Quote Visit website
LabelCompany nameLogoContactSummary
Best Debt Settlement(888) 215-2725 Get a Free Quote Visit website

Bottom line: Which one is best for you?

If you are committed to making profound and lasting changes in your spendings, savings and overall budget, and if you are committed to a long-term plan to pay off your debt, consider debt consolidation. Make sure you find the best debt consolidation company for you. If you are looking for a short-term solution to quickly reduce your debt, debt settlement may be the route to pursue. However, other options exist, and there might be a better debt relief program for your unique situation.

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Profile picture of Barbara Friedberg
by Barbara Friedberg Personal Finance Contributing Editor

Barbara Friedberg, MBA, MS is a former investment portfolio manager with decades of financial experience. Friedberg taught Finance and Investments at several universities. Her work has been featured in U.S. News & World Report, Investopedia, Yahoo!Finance and many more publications.