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Debt Settlement vs Debt Consolidation

Which credit card debt relief option is right for your credit and financial situation?

Finding the right debt relief option can be tricky. Most people don’t know about these types of programs until they need them. As a result, finding the right solution is often left to guesswork. However, given that using the wrong debt solution can lead to even greater financial distress, it’s important to familiarize with these concepts so you can make an informed decision.

What is debt consolidation vs debt settlement?

  • Debt Consolidation is a financial process that rolls multiple debts into a single, consolidated monthly payment. With credit card debt consolidation, you aim to reduce or eliminate the interest rate applied to the debt. This allows you to get out of debt faster, even though you pay less each month. It simplifies and accelerates debt repayment, making it easier to repay what you owe even on a limited budget.
  • By contrast, Debt Settlement is the financial process where you pay back a portion of what you owe in exchange for a full discharge of the remaining balance. Simply put, you settle your debt for a percentage of what you owe. The settlement is usually made in a single lump-sum payment. If you get into a settlement program with a debt settlement company, they may tell you to stop paying your creditors and let the accounts lapse. Then they put the money you would use on payments into an account that’s used later to make your settlement offer. This can be extremely rough on your credit, but it may help you avoid bankruptcy if you have no options left.

Explore consolidation first; settlement should only be a “nuclear option”

When done correctly, consolidation is not bad for your credit. In fact, you can improve your credit by completing debt consolidation successfully. You pay back everything you owe; you just do it in a way that’s more manageable for your budget. As long as you make all the payments on the consolidated debt, this builds positive credit history. You also reduce your credit utilization ratio. These are the two main factors in consumer credit score calculations, so consolidation can be positive for you credit.

There are several options for debt consolidation. If you have good credit, you can do a debt transfer to a balance transfer credit card. You can also use a personal debt consolidation loan. If you have less than perfect credit, you can also use a debt management program through a credit counseling agency. This is a repayment plan that works similarly to debt consolidation.

Since all these options can be positive for your credit, explore them first before you even consider settlement. You should only consider debt settlement the “nuclear option.” At most, it should be a last-ditch effort to avoid bankruptcy. If your credit is already bad, settlement could give you the edge to get ahead of your debt.

Comparing debt consolidation vs debt settlement side-by-side

 Debt ConsolidationDebt Settlement
Will this damage my credit?Not if it’s done correctly.Yes. Each debt settled creates a negative remark in your credit report.
How much debt does this repay?Everything you owe, but usually with reduced interest charges.This pays back a percentage of what you owe.
Is success guaranteed?No. If you fall behind on your consolidated payments, you may need to re-consolidate.No. You may stop paying your creditors, only to have your settlement offer rejected.
Can I get new financing (mortgage, auto loan) if I do this?Yes. In fact, in some cases, this can make it easier to qualify for a loan because it reduces your debt-to-income ratio.Since this negatively impacts your credit, it can drop you into subprime credit; this can make it tough to qualify for traditional loans.
Can I do this on my own or does it require professional assistance?Two options for debt consolidation are do-it-yourself; you enroll in a debt management program through a credit counseling agency.You can attempt to make a settlement offer on your own or you can use a debt settlement company; just be careful with upfront fees.

Have more questions about debt settlement vs debt consolidation? Ask our certified financial coaches now!