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. If you and your creditor(s) reach an agreement, then you would 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 Consolidation | Debt Settlement | |
| How it works | Debts are combined into a single loan with one interest rate. | Debt balances are negotiated to pay less than what’s owed. |
| Credit score impact | May 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. |
| Cost | Interest 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. |
| Pros | Combining 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. |
| Cons | Depending 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.
United Nations Federal Credit Union. "Debt Consolidation Loan."
Consumer Financial Protection Bureau. "What Is a Home Equity Loan?"
U.S. Consumer Financial Protection Bureau. "What Do I Need to Know About Debt Consolidation?"
Consumer Financial Protection Bureau. "What Is a Debt Relief Program and How Do I Know if I Should Use One?"
myFICO. "What Are the Different Types of Bankruptcy and How Is Each Considered by My FICO Score?"
Consumer Financial Protection Bureau. "What Do I Need to Know About Consolidating My Debt?"
Federal Trade Commission. "How to Get Out of Debt."
Debt consolidation and debt settlement are two different strategies for managing personal debt. Debt consolidation involves combining multiple debts into a single loan, while debt settlement involves negotiating with creditors to pay a reduced amount of debt. Let's explore these concepts in more detail.
Debt Consolidation:
Debt consolidation is a process where multiple debts are combined into a single consolidation loan. This loan pays off all the prior debts, resulting in one monthly payment at one interest rate. The consolidation loan can be obtained from banks, credit unions, or online lenders. The key benefits of debt consolidation include:
- Simplified Repayment: With debt consolidation, you only need to make one monthly payment instead of managing multiple payments for different debts.
- Lower Monthly Payment: Consolidating debts can potentially result in a lower total monthly payment, making it easier to manage your finances.
- Lower Interest Rate: Depending on the terms of the consolidation loan, you may be able to secure a lower average interest rate on your debt, which can save you money over time [[1]].
It's important to note that debt consolidation loans can be either secured or unsecured. Secured loans require collateral, such as your home or car, while unsecured loans do not require collateral. Secured loans may offer lower interest rates, but they carry the risk of losing the collateral if you default on the loan [[1]].
Debt Settlement:
Debt settlement is a strategy where you negotiate with your creditors to pay a reduced amount of debt. If an agreement is reached, you can make a lump sum payment or a series of installments to settle the debt. Here are some key points about debt settlement:
- Reduced Debt Amount: Debt settlement allows you to eliminate debts by paying less than the total amount owed. This can be an attractive alternative to bankruptcy.
- Credit Score Impact: Debt settlement can have a negative impact on your credit history. Late and past-due payment history associated with settled accounts can harm your credit score.
- Creditor Consideration: Creditors are not obligated to enter into negotiations or accept your settlement offer. They may only consider debt settlement for significantly past-due accounts.
- Cash Requirement: Debt settlement requires you to have cash on hand to make the agreed-upon payments. If you don't have the necessary funds, debt consolidation may be a better option [[1]].
It's worth mentioning that debt settlement can be done on your own or with the assistance of a debt settlement company. However, using a debt settlement company may involve fees and can take several years to complete [[1]].
Debt Consolidation vs. Debt Settlement:
Here are some key differences between debt consolidation and debt settlement:
| Debt Consolidation | Debt Settlement |
|---|---|
| Combines multiple debts into a single loan with one interest rate | Negotiates to pay less than what's owed |
| May help improve credit scores if it reduces credit utilization ratio | Late payment history for settled accounts could harm credit score |
| Interest rates and fees vary | Debt settlement companies may charge fees |
| Combines debts for easier repayment and potential interest savings | Eliminates debts for less than what's owed, potentially avoiding collection actions |
The choice between debt consolidation and debt settlement depends on your financial situation. If you need to make monthly payments more manageable, debt consolidation may be a good option. On the other hand, if you're already behind on payments and facing potential lawsuits, debt settlement could be considered. It's important to compare loan options, fees, and credit score requirements when considering debt consolidation [[1]].
How to Negotiate a Debt Settlement:
If you decide to pursue debt settlement, here are some steps to follow:
- Reach out to your creditor(s) to inquire about negotiating a settlement.
- Communicate your offer either over the phone or in writing.
- The creditor can accept, reject, or make a counteroffer.
- Evaluate the counteroffer and determine if it aligns with your budget.
- Once an agreement is reached, arrange to make the payment in a lump sum or installments.
- Keep a record of all communications and payments related to the settlement [[1]].
If you're not comfortable negotiating on your own, you can hire a debt settlement company to assist you. However, be aware that this may involve fees and can take time to complete [[1]].
In conclusion, debt consolidation and debt settlement are two different strategies for managing personal debt. Debt consolidation combines multiple debts into a single loan, while debt settlement involves negotiating with creditors to pay a reduced amount. The choice between the two depends on your financial situation and goals. It's important to consider the pros and cons of each strategy and explore the available options before making a decision [[1]].
