Debt Consolidation vs. Debt Settlement

What is debt consolidation?

Debt consolidation combines multiple debts into one debt with a single interest rate. This way, you won’t have to worry about paying multiple lenders with varying annual percentage rates (APRs), due dates and minimum payments. Instead, you’ll only track one balance, meaning you’re less likely to miss payments and incur fees.

Debt consolidation can provide benefits like simplified payments, stress relief and possibly a lower overall interest rate.

“You have the opportunity to save money [with debt consolidation], which could translate to hundreds, if not thousands, of dollars over the life of your loan should you be able to secure a lower APR,” said Christopher Stroup, founder and president of Silicon Beach Financial, a financial advisor.

However, you’ll typically need good credit or better to qualify for most types of debt consolidation.

Debt consolidation methods

Some of the main debt consolidation methods are debt consolidation loans, balance transfer credit cards and home equity loans.

Debt consolidation loans

Debt consolidation loans are personal loans specifically designed to consolidate debt. Many banks, credit unions and specialized lenders offer debt consolidation loans. Debt consolidation loans generally have lower APRs than credit cards, though you’ll typically need good to excellent credit to qualify for the best interest rates.

Keep in mind that some lenders offer long loan terms, which could lead to paying more interest overall than if you were to continue paying off your debts separately. However, if combining multiple debts is more manageable, it may help you to pay down more debt.

Balance transfer credit cards

Balance transfer credit cards allow you to transfer high-interest credit card debt to a single credit card with a 0% introductory APR offer. These cards typically offer up to 21 months of 0% interest, giving you some time to pay off your debt without paying interest charges.

However, balance transfer cards typically come with a 3% to 5% balance transfer fee, which can impact any potential savings from consolidating your credit card debt. Plus, you’ll need to make sure you pay off your balance before the 0% intro APR offer expires or your balance will be subject to a potentially high interest rate.

Home equity loans

Home equity loans allow you to take out a loan using the equity in your home as collateral. You can use your home equity loan as a debt consolidation loan by taking the lump sum you receive from your lender and using it to pay off multiple debts.

Because home equity loans are secured by your home, they may come with lower interest rates than unsecured loans. But they’re also risky: If you don’t make your home equity loan payments, the lender might foreclose on your home.

» MORE: How to consolidate debt without a loan

Pros and cons of debt consolidation

Consider the pros and cons of debt consolidation before going this route:

What is debt settlement?

Debt settlement is when you negotiate with a lender to pay less than you owe. Most lenders will only consider debt settlement if the account is significantly overdue and if you have the cash on hand to settle it. Lenders might be willing to negotiate if it means it’ll get something as opposed to nothing.

Debt settlement is typically a last resort after pursuing other debt management methods.

Settling debt may help you to speed up debt payoff, allowing you to get out of debt faster.

“The pros of debt settlement include speeding up the repayment process, reducing the total amount owed and simplifying your repayment plan,” Stroup said. “By negotiating with creditors to settle for less than the full amount, you can quickly lower debt and save money.”

While debt settlement may be able to reduce your debt load, it will damage your credit in the process. You’ll also owe taxes on forgiven debt of $600 or more. Plus, there’s no guarantee that a creditor will be willing to negotiate or accept a settlement offer. This is why debt settlement is often considered to be a last resort after tactics like debt consolidation or credit counseling.

Debt settlement methods

There are two main ways you can approach a debt settlement: You can try the do-it-yourself (DIY) approach or hire a third-party debt settlement company.

DIY debt settlement

DIY debt settlement is when you opt to negotiate with each lender on your own. It involves explaining your financial situation and proposing a reasonable settlement amount. While you may not get the same results as you would with a debt settlement attorney or debt settlement company, you can at least save time and fees by attempting to negotiate your debts on your own.

Third-party debt settlement companies

Third-party debt settlement companies, also known as debt relief companies, can negotiate with lenders on your behalf, acquire a debt settlement agreement for your approval and set up a payment plan. Legitimate debt settlement companies will not charge fees upfront and will instead charge a settlement fee. This fee is usually up to 25% of the enrolled debt.

Pros and cons of debt settlement

Before pursuing debt settlement, compare the pros and cons:

Comparison: debt consolidation vs. debt settlement

Debt consolidation and debt settlement are two different ways to approach debt, with the former focused on management and the latter focused on reduction. There are advantages and disadvantages to both options.

The table below shows how debt consolidation compares with debt settlement:

Alternative ways to manage debt

Debt consolidation and debt settlement are just two of many debt-reduction strategies you can implement to effectively manage your debt load.

Credit counseling

Credit counseling involves working with a counselor through a nonprofit agency. A credit counselor can help you manage your finances, set up a debt management plan and rebuild your credit.

Debt snowball method

The debt snowball method is a debt repayment strategy that involves paying off your debts from the smallest to the largest balance. This method can help you pay off small debts faster, which may provide momentum and motivation to help you pay off the rest of your debt.

Debt avalanche method

The debt avalanche method involves paying off your debts from the highest to lowest interest rate. This method may result in paying less interest over time, but it may take longer to pay off each debt, making it less motivating than the snowball method.

» MORE: How to get out of debt

Bottom line

Debt consolidation involves rolling your debts into a single balance to simplify your finances, avoid missed payments and possibly reduce your interest rate. Debt settlement involves negotiating outstanding balances with creditors to reduce how much you owe.

Debt settlement is often considered to be a last resort before declaring bankruptcy. If you’re simply looking to better manage your existing debts, it’s typically best to start with credit counseling or debt consolidation.