December 18, 2023

Debt Consolidation vs Debt Settlement

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Debt consolidation and debt settlement both help you settle your debts. But they have their differences. Read on to know the better option.

Debt consolidation allows you to combine multiple debts into one. Debt settlement, on the other hand, helps you settle each debt for a much lower amount.

There are pros and cons to each. And one option would be better than the other, depending on your priorities.

At the end of this guide, you may be able to choose which to go for.

Have you ever used a debt relief strategy to manage your debts?

Is Debt Consolidation or Debt Settlement Better?

Debt consolidation, as the name suggests, consolidates different debts into one large debt. This makes your debts more manageable.

On the flip side, debt settlement involves negotiating with your creditors to reduce your debt amount or have better payment terms. This makes them more affordable and easier to pay off.

Having said that,

  • Choose debt consolidation if: you want to focus on settling one payment with one interest rate. This lets you eliminate high-interest loans, hefty charges, and heavy penalties for each debt.

  • Choose debt settlement if: you want new debt terms. You could negotiate for reduced debts and have lower monthly installments. You could pay significantly less than what you originally owe.

Here's a breakdown of how they work.

Which factor is most important to you when choosing between debt consolidation and debt settlement?

How Does Debt Consolidation Work?

Debt consolidation starts with merging debts. Here's the process:

  1. Assess all the debts you want to consolidate. You can include your credit card debts, high-interest personal loans, and medical bills.
  2. Weigh your debt consolidation options. Take out a new loan or credit to settle all existing debts you want to pay off.
  3. Make timely monthly payments with your new larger debt. Keep doing this until you fully pay it off.

The key is to find a consolidation option that has a lower interest and fewer fees compared to your existing debts. This way, it can also be more affordable.

Does debt consolidation affect your credit?
Yes, debt consolidation affects your credit since you will be taking out either a new loan or credit. It's a hard inquiry that shows up in your credit, decreasing your credit score temporarily. But if you keep monthly payments on time, debt consolidation can improve your credit eventually.

Debt Consolidation Pros and Cons

Although debt consolidation can help you pay off your debts, there are downsides to it.


  • Avoid paying off high-interest for individual debts
  • Eliminate other charges associated with each debt
  • One payment for many debts (simplifies debt management)
  • Shorten repayment period
  • Lessen your number of creditors
  • Can improve your credit over time with on-time payments


  • May not reduce the principal amount of the debt
  • You may pay more for interest and charges if you choose longer terms
  • May require good credit and financial standing
  • Origination fees or transfer fees
  • Your asset may be used as a collateral
  • Does not help fix poor financial habits

Now, let's delve into debt settlement.

How Does Debt Settlement Work?

Debt settlement involves negotiating with your creditors to reduce the debt amount you owe or have better payment terms. Creditors may also allow you to settle the lower amount in a structured installment payment.

Here's how it generally works:

  1. You intentionally miss your debt payments and instead put your monthly payments in a dedicated account to be used later.
  2. You or a debt relief company contacts your creditors to negotiate.
  3. Once you reach an agreement with the creditor, you pay off the new debt amount with your accumulated funds (in the dedicated account).

Normally, when a creditor agrees with the proposed reduced debt, you'll only have a few days to settle using a lump sum payment.

But if you've arranged new payment terms for monthly installments, you just need to focus on making timely payments.

Does debt settlement destroy your credit?
Yes, debt settlement can negatively impact your credit. You need to miss out on some payments and this can result in negative items in your credit report, dragging down your credit score. It's a risk you need to assess so you can bargain for lower amounts on your existing debt balances.

Debt Settlement Pros and Cons

Just like debt consolidation, debt settlement has its upsides and downsides, too.


  • Can reduce the principal amount of your debt
  • Eliminate interest fees, penalties, and charges
  • Minimize creditor calls and collections actions
  • You can shorten the repayment period of the debt
  • No credit requirements
  • Avoid bankruptcy


  • Possibility of lawsuits from your creditors
  • Your creditors are not obliged to settle for a lower amount
  • Can drop your credit score due to missed payments
  • Gain missed payments, late payments, or collection accounts on your credit report
  • Debt relief companies have a minimum debt to apply
  • Companies usually qualifies unsecured debts only
  • Debt settlement fees can be expensive
  • Penalties, interest, and other charges continue to accumulate when you miss your payments

What is the difference between debt settlement and debt resolution?
There is no difference between debt settlement and debt resolution. You either hire a company or negotiate with creditors on your own to lower your debts. This is also known as debt negotiation or debt adjusting.[1]

Sometimes, the two debt relief options can get confusing. Here are some common qualities they share.

What is your biggest concern about using debt settlement as a strategy for managing debt?

Key Similarities

Debt consolidation and debt settlement are both:

  • Financial strategies to help you manage your debts; they're also good alternatives to bankruptcy
  • Helpful in paying off your debts faster
  • Simplify your current debt situation
  • Have eligibility requirements
  • Time-consuming (usually takes a couple of years)

Mainly, the goal for both debt consolidation and debt settlement is to reduce how much you owe so you can afford to settle debts. They come in the form of lower debt amounts, lower interest rates, eliminated fees, or negotiated terms.

Is debt consolidation the same as debt settlement?
No, debt consolidation and debt settlement are forms of debt relief, but they're not the same. Debt consolidation means combining multiple debts to avoid multiple interests and fees. Debt settlement means negotiating with creditors to lessen debt amounts. This makes debts easier to pay off.

Let's break apart the nitty-gritty details of debt consolidation and debt settlement. Here's how they really differ.

Debt Consolidation vs Debt Settlement: Detailed Comparison + Which is Better

The differences between debt settlement and debt consolidation lie in their fees, covered debts, credit impact, and potential savings.

There are also varying services, accounts, and tax and legal implications for both. Keep reading to learn about each of them.

1. Fees — Winner: Tie

The cost for both options depends on your unique circumstances. For instance, debt consolidation interest rates differ. You should select a debt consolidation option with a lower interest rate and fees than your individual debts to make it effective.

For most debt consolidation options, you don't reduce the principal amounts you owe. But you save money from interest fees and potential charges associated with each debt.

With debt settlement, you can negotiate debts by yourself or work with a debt relief company. Debt relief companies charge around 15–25% (or more) of your total enrolled debts. If you yourself will negotiate with creditors, it then costs $0.

Debt relief companies may have other fees. But note that it's illegal for them to charge upfront fees before performing any service. You shouldn't pay service fees unless you approve the new settlement amount for your debts.

2. Covered Debts — Winner: Debt Consolidation

In general, most consolidation options allow you to consolidate unsecured and secured debts like home loans and auto loan.

You may also think of debt consolidation as a way to refinance and optimize your debts against high interest rates and other fees.

On the other hand, most debt settlement companies only cover unsecured debts. If you opt for a debt relief company, you'll need to clarify which specific types of debts they support.

Unsecured debts are debts that are not tied to collateral like your assets. So your creditors can't take your house, vehicles, jewelry, or investment accounts in case you default on a loan.

3. Credit Impact — Winner: Debt Consolidation

Debt consolidation can temporarily lower your credit score because of the hard inquiry from lenders during your application.

In the long run, you can use on-time payments from your debt consolidation option to build better credit.

On the other hand, debt settlement can really hurt your credit since you're intentionally missing payments to leverage negotiations.

You might end up with missed payments, late payments, charge-offs, or collection accounts that can stay on your credit report for up to 7 years.[2]

4. Duration — Winner: Tie

Both debt consolidation and debt settlement have different timelines. If you opt for a debt consolidation loan, your duration depends on the term you qualify for.

On the other hand, the timeline for debt settlement depends on how many debts you want to negotiate.

You may end up settling all your debts quickly if negotiations are fast. And you can pay off the lower amounts as soon as you can.

Both options may take a couple of years to finish, but they may still take less time than if you settle your debts one by one.

Debt Consolidation & Debt Settlement vs. Minimum Debt Payments
Generally, it will take you years to become debt-free. But it can be faster with debt consolidation and debt settlement compared to making only minimum payments with your debts.

If you choose to pay the minimum monthly, it can take you decades to completely settle your debts. Interest fees may be more than your original debts at that point.

5. Debt Savings — Winner: Debt Settlement

You are saving more from the principal amount of your debts with debt settlement. This is because you're negotiating for a lower total amount you can pay off, including the fees and charges from the missed payments.

On the other hand, debt consolidation saves you from potentially high interest fees on each debt. You also eliminate multiple fees and charges that can arise from missed payments. But you don't always get to save from the principal amount.

In general, each person has a unique situation regarding debts and finances. Your savings will depend on your overall standing once you settle your debts.

6. Types of Services — Winner: Tie

While debt settlement negotiates for each debt, debt consolidation offers multiple methods. You may find what you need from either option.

The most common debt consolidation methods include debt consolidation loans, home equity loan and home equity line of credit (HELOC), and balance transfer credit card.

  • Debt consolidation loans

    A debt consolidation loan is a larger loan with lower interest and better terms than each of your debts. It's typically offered by credit unions, local banks, and lenders.

    The loan can also be secured or unsecured. Credit requirements and eligibility will depend on your lender.

    How long do debt consolidation loans stay on your credit?
    Debt consolidation loans will stay in your credit as long as the debt is open and you are still paying off the balances. However, it's best to pay your new loan payments on time. Or else, you risk gaining negative items on your credit report, which can stay up to 7 years.

  • Home equity loan & home equity line of credit

    Both the home equity loan and HELOC are flexible methods of debt consolidation. The more equity you have in your home, the larger you can borrow and use to pay off all your other debts.

    For both options, you'll use your home as collateral. But with HELOC, you get a line of credit instead of a loan to pay off your current debts.

    Many home equity loans and HELOCs feature competitive interest rates compared to other types of loans.

  • Balance transfer credit card

    A balance transfer credit card is a credit card you can use to transfer the existing balances of other credit cards. This type of debt consolidation option is primarily for credit card debts.

    A balance transfer credit card can pay off your current credit card balances while offering low or even zero interest rates (for introductory rates).

    You get to save on interest fees you may have potentially paid in the long run for each credit card. The best part? You can use this new credit card to build credit as well. Just make sure to make timely payments to build a good payment history.

Can I still use my credit card after debt consolidation?
Yes, you can still use your credit card after debt consolidation. But it's best to keep an eye on your spending. Make sure to spend only what you can afford to pay off. This way, you can avoid accruing more debt than you can settle.

7. Accounts — Winner: Debt Consolidation

You can still use and access your accounts with debt consolidation. For example, even if you have paid all your credit card balances with a bigger loan, you can keep these credit accounts open.

On the other hand, it's not the case for debt settlement. Since you will completely stop paying and using that account during negotiations, you can't keep using it.

One way to improve your credit is paying off each smaller debt and keeping the account open. This ages your account and minimizes credit utilization. But if you've settled all your balances, use these accounts sparingly to avoid getting yourself into more debt.

8. Tax Implications — Winner: Debt Consolidation

Debt consolidation has no direct tax implications. However, debt settlement can result in taxes on the forgiven portion of the debt.

Once the forgiven portion of your negotiated debt goes over $600, it can be considered as income — which is taxable.[3]

There are legal implications for both debt consolidation and debt settlement. Creditors can go after you for your new debt, depending on the debt consolidation option you took. However, old creditors can't take legal action against you once you pay off your old debt.

With debt settlement, once you stop paying your debt payments monthly, creditors can take legal action against you for not paying your dues.

It's one of the biggest risks for debt settlement. You're setting up a slight chance of lawsuits from your existing debts before negotiations begin.

Statute of Limitations (SOL) on Debts
The Statute of Limitations for debts refers to the amount of time creditors have to take legal action against you. The SOL for each debt varies per state and usually lasts 3–6 years after your date of delinquency (date of your last payment).

Debt Consolidation and Debt Settlement Alternatives

If neither solution fits your needs, there are other ways to help you relieve yourself of debt:

  • Credit counseling
    Credit counseling refers to a financial service that provides education and guidance about finance. It covers topics on credit, debt, budgeting, etc.

    Nonprofit agencies typically offer these services through licensed professionals. You'll be given advice depending on your current situation.

  • Bankruptcy
    Bankruptcy is a legal procedure that helps you liquidate your assets to cover your debts. It also involves creating a repayment plan.

    That catch is, it's a complex procedure and has a lasting impact on your credit. It can stay on your credit report for 10 years.[4] Plus, you need to hire professionals with expertise in bankruptcy to get this service.

  • DIY debt relief
    If you prefer, you can perform debt settlement yourself. You'll need to do what companies do, which is to negotiate for each debt for lower debt amounts or better terms.

    If you can come to an agreement with your creditors, keep the new deal in writing. Then pay off the negotiated debts.

    Performing these things yourself saves you hefty settlement fees you'd pay to debt relief companies.

Bottom Line

Choose debt consolidation options if you want to retain your credit standing. However, eligibility requirements might be stricter since you'll be taking a larger debt to settle smaller ones.

On the other hand, choose debt settlement if you want the possibility of smaller debts. But you will be at risk for lower credit and potential lawsuits. Your creditors may not even agree to your requests.

Overall, there's no one-size-fits-all solution to debt. Each person has a unique situation. And you need to analyze the types of debts you have to weigh your options.


  1. ^ Consumer Financial Protection Bureau. What is a debt relief program and how do I know if I should use one?, Retrieved 09/15/2023
  2. ^ Federal Trade Commission Consumer Advice. Debt Collection FAQs, Retrieved 11/26/2023
  3. ^ IRS. About Form 1099-C, Cancellation of Debt, Retrieved 11/26/2023
  4. ^ How long can a bankruptcy stay on my credit report?, Retrieved 11/25/2023

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