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The Difference Between Debt Consolidation and Debt Settlement

Written by Allison Martin

Allison Martin is a personal finance enthusiast and a passionate entrepreneur. With over a decade of experience, Allison has made a name for herself as a syndicated financial writer. Her articles are published in leading publications, like, Bankrate, The Wall Street Journal, MSN Money, and Investopedia. When she’s not busy creating content, Allison travels nationwide, sharing her knowledge and expertise in financial literacy and entrepreneurship through interactive workshops and programs. She also works as a Certified Financial Education Instructor (CFEI) dedicated to helping people from all walks of life achieve financial freedom and success.

Updated May 21, 2023​

3 min. read​

debt consolidation vs debt settlement

Debt consolidation and debt settlement are both options that can help you get a handle on your debt. However, there are key differences between the two to be aware of. Read on to learn more about how they work, the pros and cons of each, and how to identify which debt relief solution is most ideal for your financial situation.

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What Is Debt Consolidation?

Debt consolidation involves using a new debt product to pay off existing debts. It streamlines the repayment process as you’ll only have to make one monthly payment. Many consumers use debt consolidation loans and balance transfer credit cards to get out of debt faster.

Debt consolidation loans are offered by traditional banks, credit unions, and online lenders. They are unsecured debt products that generally offer lower interest rates than you’d find with credit cards and could help you get out of debt faster. You get the loan proceeds in a lump sum, and you can use the funds to pay off high-interest debts. But here’s the trick: If you spend the funds elsewhere, you could end up with an even greater debt load.

Balance transfer credit cards do not assess interest for a set period. Still, the idea is to eliminate the balances before the zero-interest introductory window ends. Otherwise, you could spend a fortune in interest.

How Does Debt Consolidation Work?

Below is a scenario that demonstrates how debt consolidation works:

  • Credit card #1: $350 balance, 15.9% interest rate, $18 minimum monthly payment, 23-month balance payoff term, and $57 in total interest paid
  • Credit card #2: $450 balance, 17.9% interest rate, $20 minimum monthly payment, 28-month balance payoff term and $102 in total interest paid
  • Credit card #3: $600 balance, 19.9% interest rate, $28 minimum monthly payment, 27-month payoff term, and $147 in total interest paid

If you get approved for a $1,400, 36-month debt consolidation loan with a 7% interest rate, your monthly payment will drop from $66 to $43. Even better, you will only pay $156 in interest over the loan term.

Debt Consolidation: Pros and Cons

Consider the benefits and drawbacks of debt consolidation before moving forward.

Pros of Debt Consolidation:

  • You could lower your monthly payments and save hundreds or thousands of dollars in interest.
  • It’s easier to manage your debt since you won’t have to pay several creditors each month.
  • Your credit score could improve as your utilization ratio will likely increase.

Cons of Debt Consolidation:

  • You may not qualify for a more competitive interest rate if you have less than perfect credit.
  • You could acquire more debt if you consolidate your credit cards and continue to swipe away for new purchases.
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What Is Debt Settlement?

When you settle your debt, the lender or creditor allows you to pay a fraction of what you owe to settle your account. You can negotiate settlement offers on your own or hire a company to do it for you.

How Does Debt Settlement Work?

If you hire a company to settle your debts, the process generally works as follows:

  • Step 1: Research debt settlement companies.
  • Step 2: Choose the best fit and enroll in a debt settlement program. A debt counselor will work with you to devise a plan of action.
  • Step 3: Make the agreed-upon monthly payments to a dedicated account. (Many consumers voluntarily forgo making payments on their debts as this could speed up the settlement process. However, late payments could damage your credit score).
  • Step 4: When the balance in the dedicated account reaches a certain level, the debt settlement company will begin negotiating with lenders and creditors on your behalf.
  • Step 5: Each time a settlement is reached, the debt settlement company will reach out to obtain your approval. If you agree to the terms, funds will be sent from your dedicated account to settle the debt.
  • Step 6: Continue making deposits to your dedicated account until all the enrolled debts go through negotiations.

Debt Settlement: Pros and Cons

Here are the key advantages and disadvantages of debt settlement.

Pros of Debt Settlement:

  • You could settle your debts for far less than what you actually owe.
  • You could avoid spending a fortune in interest over time.
  • You could get out of debt in as little as 24 to 48 months.
  • You could get your accounts under control and avoid filing for bankruptcy.

Cons of Debt Settlement:

  • Your credit score will likely take a hit during and possibly after the debt settlement process.
  • You will pay a fee between 15 and 25 percent of the settled amount when a debt is settled.
  • You could be liable for federal income tax on the portion of the debt that’s forgiven.
  • The lender or creditor may not accept your settlement offer.
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Debt Consolidation vs. Debt Settlement: How Do They Differ?

Debt consolidation refers to rolling all your debts into a single product, typically with a lower rate, to save on interest and repay what you owe faster. However, settling your debt means you’ll only pay the creditor or lender a fraction of what you owe.

If you get a debt consolidation loan, you’ll likely pay a loan origination fee. By contrast, debt settlement companies usually charge a flat fee between 15 and 25 percent of the settled amount each time a debt is settled (unless you take the DIY approach).

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

Both have pros and cons, but the best fit for you depends on your financial situation and debt-management goals.

When Is Debt Consolidation a Good Idea?

Debt consolidation is ideal for consumers with good or excellent credit who can afford to make monthly debt payments. You’ll need a strong credit score to qualify for a loan with an interest rate lower than what you’re currently paying. And you also want to ensure you can make the monthly payments on the debt consolidation product you select.

When Is Debt Settlement a Good Idea?

You may find debt settlement more beneficial if you’re contemplating bankruptcy because you’re behind on debt payments or if you’re struggling to stay afloat financially. While there’s a chance your creditors and lenders could reject settlement offers, you’ll have a chance at getting your debts resolved for far less than what you owe.

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