What’s the Difference Between Debt Consolidation and Debt Settlement? (2024)

Debt consolidation and debt settlement are both financial strategies for improving personal debt load, but they are quite different in how they resolve different issues. Essentially, debt settlement reduces the total amount of debt owed, while debt consolidation reduces the total number of creditors you owe. Learn about the pros and cons of each strategy.

Key Takeaways

  • Debt consolidation and debt settlement both help you reduce your debt load but in different ways.
  • Debt settlement reduces your total debt owed, while debt consolidation reduces the totalnumber of creditors that you owe.
  • With debt consolidation, multiple loans are all rolled into a new consolidation loan that has one monthly interest rate.
  • With debt settlement, either you or a credit counselor negotiates with your creditors so that you can pay a lower amount than what you owe.

What Is Debt Consolidation?

Debt consolidation is a process in which you combine multiple debts into a consolidation loan. This is a single loan that rolls all of your prior debts into one loan, resulting in one monthly payment at one interest rate.

Consolidation loans are offered through banks, credit unions, and online lenders—and all of your debt payments are made to the new lender going forward.

Consolidating debt in this way can relieve the stress of having to juggle multiple debt payments each month. A consolidation loan may result in a lower total monthly payment or a lower average interest rate on your debt. Whether you’re able to save money on interest over time may depend on the length of the loan repayment term and/or whether you pay any fees for the loan, such as application or origination fees.

A debt consolidation loan may be secured or unsecured. Secured debt consolidation loans require you to use one or more assets as collateral, such as your home, car, retirement account, or insurance policy. For example, if you take out a home equity loan to consolidate debt, then your home would secure the loan.

Debt consolidation could help improve your credit score if you reduce your credit utilization ratio, but it’s important to monitor your credit reports and scores for any potentially negative impacts.

What Is Debt Settlement?

Debt settlement utilizes a very different strategy. When you settle debt, you’re effectively asking one or more of your creditors to accept less than what you owe—known as a discounted payoff (DPO). If you and your creditor(s) reach an agreement, then you will pay the settlement amount in a lump sum or a series of installments.

The advantage of debt settlement is that you can eliminate debts without having to pay the balance in full. This may be an attractive alternative to bankruptcy, although it will also have a damaging effect on your credit history.

Keep in mind that creditors are under no obligation to enter negotiations or accept your offer. Additionally, offering a settlement requires you to have cash on hand to pay agreed-upon amounts. If you don’t have the cash to negotiate with, then seeking a debt consolidation loan may be the better option.

Typically, creditors will only consider debt settlement for accounts that are significantly past due. Therefore, if you’re still current on your balances, then this may not be an option.

Debt Consolidation vs. Debt Settlement: Key Differences
Debt ConsolidationDebt Settlement
How it worksDebts are combined into a single loan with one interest rate.Debt balances are negotiated to pay less than what’s owed.
Credit score impactMay help improve credit scores if it reduces your credit utilization ratio.Late and past-due payment history for a settled account could hurt your credit score.
CostInterest rates for debt consolidation loans vary; some lenders may also charge fees.Debt settlement may cost nothing if you do it yourself, but debt settlement companies charge a fee for their services.
ProsCombining debts into a single payment could make repayment easier, and you may be able to save money on interest.You can eliminate debts for less than what’s owed and might head off collection actions, including creditor lawsuits.
ConsDepending on the length of the loan term, you could pay more in total interest over time.Not all creditors may agree to a debt settlement, and late payment history will harm your credit rating. Any forgiven debt may be taxed as income as well.

How to Negotiate a Debt Settlement

Debt settlement requires you to have some bargaining skills, but the process itself is not that complicated. If you’re behind on one or more debts, then you would begin by reaching out to your creditor to ask if they’re open to negotiating a settlement. You can do this over the phone, but if you prefer to have a paper trail, then you can send a written request.

At this point, the creditor can do one of three things: accept your settlement offer, reject it, or make a counteroffer. If your creditor chooses to counteroffer, then you can weigh whether the amount they’re asking for is realistic for your budget.

Once you and a creditor agree on a settlement amount, you can arrange to make the payment. You may be asked to make a single lump-sum payment or several installment payments, depending on the creditor. Your method of payment may vary and includes sending an electronic payment from your bank account, wire transfer, or paper check.

After a debt is settled, it’s gone—the remaining balance is wiped clean. However, with unsecured debts such as credit cards, you risk having your account closed completely after the settlement is made because the lender willnot want to continue to grant you credit. This, along with any late payment history associated with the account, could cost you credit score points.

If you aren’t comfortable with negotiating debt settlement on your own, then you can hire a debt settlement company to do so on your behalf. Be aware that this will likely involve paying a fee, and can take years to complete. You may contact the Federal Trade Commission or the National Consumer Law Center for free information on debt negotiation and debt negotiators.

Create a paper trail of all communications and payments regarding debt settlements in case a creditor tries to claim payment for any forgiven balance.

Debt Consolidation vs. Debt Settlement: Which One Is Better?

If you’re considering the best way to manage debts, then you may be weighing debt consolidation against debt settlement. One may very well be a better choice than the other, depending on your financial situation.

For example, if you simply need a way to make your monthly payments more manageable, then consolidating debts into a single loan could make sense. Keep in mind that you’ll need good credit to qualify for the lowest rates on personal loans for debt consolidation.

If you’re already behind on payments for one or more debts and your creditors are threatening to sue, then you might consider debt settlement instead. Assuming you have cash available to make settlement payments with, this could be less financially damaging than filing for bankruptcy protection.

If you’re looking for debt consolidation loans, take time to compare the annual percentage rate (APR), fees, loan repayment terms, and minimum credit score requirements to find the best loan options.

What Type of Loan Is a Debt Consolidation?

A debt consolidation loan is generally an installment loan with a fixed term and fixed payments that you use to pay off other loans. You can also use other types of loans, like a home equity line of credit, which is a revolving loan, to consolidate debt.

How Do I Know a Debt Consolidation Company Is Reputable?

When you use a debt consolidation company, look for signs of scams, as this industry attracts fraudsters. Signs of a scam may include a lack of communication, high fees that are requested before service, and calls for you to stop paying creditors. If you feel like a debt consolidation company is being pushy, consider it a red flag for a possible scam.

Who Qualifies for Debt Settlement?

To qualify for debt settlement, you will need to prove you are struggling financially, typically by being more than 90 days past due on your accounts. When you are delinquent, creditors may be willing to work with you toward a resolution to try to recoup at least some of the funds that you owe them. The best debt relief companies charge reasonable fees by industry standards, have strong customer service ratings, and are free of regulatory actions.

The Bottom Line

Debt settlement and debt consolidation are both useful strategies for addressing financial struggles to help you stay in good financial health. Which method is right for you will depend on your personal circ*mstances, including whether you can afford to make payments with a consolidation. Bankruptcy may be considered as a last resort to manage a debt problem. Consider consulting with a professional financial advisor who can review the best options for your situation.

Article Sources

Investopedia requires writers to use primary sources to support their work. These include white papers, government data, original reporting, and interviews with industry experts. We also reference original research from other reputable publishers where appropriate. You can learn more about the standards we follow in producing accurate, unbiased content in oureditorial policy.

  1. United Nations Federal Credit Union. "Debt Consolidation Loan."

  2. Consumer Financial Protection Bureau. "What Is a Home Equity Loan?"

  3. U.S. Consumer Financial Protection Bureau. "What Do I Need to Know About Debt Consolidation?"

  4. Consumer Financial Protection Bureau. "What Is a Debt Relief Program and How Do I Know if I Should Use One?"

  5. myFICO. "What Are the Different Types of Bankruptcy and How Is Each Considered by My FICO Score?"

  6. Consumer Financial Protection Bureau. "What Do I Need to Know About Consolidating My Debt?"

  7. Federal Trade Commission. "How to Get Out of Debt."

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What’s the Difference Between Debt Consolidation and Debt Settlement? (2024)


What’s the Difference Between Debt Consolidation and Debt Settlement? ›

Debt consolidation and debt settlement are both financial strategies for improving personal debt load, but they are quite different in how they resolve different issues. Essentially, debt settlement reduces the total amount of debt owed, while debt consolidation reduces the total number of creditors you owe.

Is it better to settle or consolidate 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.

Does debt settlement destroy your credit? ›

Debt settlement can eliminate outstanding obligations, but it can negatively impact your credit score. Stronger credit scores may be more significantly impacted by a debt settlement. The best type of debt to settle is a single large obligation that is one to three years past due.

Is debt settlement a good idea? ›

Debt settlement is a risky way to reduce your debts. It will help you avoid bankruptcy, but depending on the settlement amount, you may be stuck paying extra taxes. Many debt settlement companies charge high fees and take years to negotiate your debts fully.

What is a disadvantage of debt consolidation? ›

Your debt consolidation loan could come with more interest than you currently pay on your debts. This can happen for several reasons, including your current credit score. If it's on the lower end, lenders see you as a higher risk for default. You'll likely pay more for credit and be able to borrow less.

Does debt settlement close your account? ›

Debt settlement can cause your credit score to fall by more than 100 points, and it stays on your credit report for seven years. If your creditors close accounts as part of the settlement process, this can cause your credit utilization to increase, which also negatively affects your credit score.

How much debt is too much to consolidate? ›

Debt consolidation is a good idea if your monthly debt payments (including mortgage or rent) don't exceed 50% of your monthly gross income, and if you have enough cash flow to cover debt payments.

How long does it take to rebuild credit after debt settlement? ›

There is a high probability that you will be affected for a couple of months or even years after settling your debts. However, a debt settlement does not mean that your life needs to stop. You can begin rebuilding your credit score little by little. Your credit score will usually take between 6-24 months to improve.

Can I still use my credit card after debt settlement? ›

If a credit card account remains open after you've paid it off through debt consolidation, you can still use it. However, running up another balance could make it difficult to pay off your debt consolidation account.

Can I buy a house after debt settlement? ›

If their credit scores are good enough, a home buyer can qualify for a conventional mortgage while still in debt settlement,” says Dan Green, CEO of Homebuyer.com. “There's no designated waiting period like with a bankruptcy or recent short sale.”

Why is debt settlement risky? ›

Working with a debt settlement company may lead to a creditor filing a debt collection lawsuit against you. Unless the debt settlement company settles all or most of your debts, the built-up penalties and fees on the unsettled debts may wipe out any savings the debt settlement company achieves on the debts it settles.

What are the risks of debt settlement? ›

Debt settlement can be done on your own or through a third party, depending on your needs. Risks include creditors not agreeing to settle and more damage to your credit score. You may need to pay taxes on any amount settled, so talk to a tax professional before pursuing settlement.

How much should I pay to settle a debt? ›

Original creditors usually expect higher settlements, around 50% to 75% of the total balance, particularly for lump sum payments. Payment plans are an option but often result in paying more over time. It's important to propose a realistic plan based on your budget, without overcommitting to an amount you cannot afford.

Can I be denied debt consolidation? ›

Lenders like to see a credit score of at least 670 for a debt consolidation loan, but probably closer to 700 just to be safe. It's not the only factor that matters, but a low credit score could stop you from getting a debt consolidation loan with reasonable interest rates and terms.

What is the best debt consolidation company? ›

  • SoFi. : Best debt consolidation loan.
  • Oportun. : Best for borrowers with bad credit.
  • Best Egg. : Best for secured loans.
  • PenFed Credit Union. : Best for low rates and fees.
  • Laurel Road. : Best for pre-qualification.
  • OneMain Financial. : Best for fast funding.
  • LendingClub. ...
  • First Tech Federal Credit Union.

Is it smart to consolidate debt? ›

Consolidating debt can be a good idea if you have good credit and can qualify for better terms than what you have now and you can afford the new monthly payments. However, you might think twice about it if your credit needs some work, your debt burden is small or your debt situation is dire.

Does consolidation hurt your credit? ›

If you do it right, debt consolidation might slightly decrease your score temporarily. The drop will come from a hard inquiry that appears on your credit reports every time you apply for credit. But, according to Experian, the decrease is normally less than 5 points and your score should rebound within a few months.

How long does debt settlement stay on your credit report? ›

As with most other negative credit report entries, settled accounts stay on your credit reports for seven years.

How long does debt consolidation stay on your record? ›

Debt consolidation itself doesn't show up on your credit reports, but any new loans or credit card accounts you open to consolidate your debt will. Most accounts will show up for 10 years after you close them, and any missed payments will show up for seven years from the date you missed the payment.


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