Debt Consolidation vs. Debt Settlement: What’s the Difference? And Which One Is Right for You?

difference between debt consolidation and debt settlement

If you’re feeling anxious about how much you owe and wondering how to deal with it, you’ve likely bumped into the terms “debt consolidation” and “debt settlement.” They might sound similar and each can offer help when you’re in this financial situation, but they address the challenge in distinct ways. Here is what you need to know about the difference between debt consolidation and debt settlement so you can make the best choice for your situation.

First things first…

Assess Your Debt Profile

Before looking into the differences between debt consolidation and debt settlement, you’ll want to conduct a thorough inventory of your debt profile. To do this, create a list citing all your debts, their respective interest rates, and your monthly payment obligations. Do not include collateralized, or secured, debts — meaning that they are guaranteed by an asset, such as a home mortgage or a car loan — as these types of debts cannot be consolidated or settled. (Typically, if you become delinquent on secured debts, the asset will be reclaimed after a period of non-payment.)

When listing your debts, it’s always smart to check your credit report, to be sure you have captured all of your obligations. You can take advantage of a free report once a year, such as one from This detailed look at your debts will serve as the foundation for choosing the consolidation method that will work best for you.

difference between debt consolidation and debt settlement

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Create a Realistic Budget

One of the keys to successful debt consolidation is aligning your repayment plan with a realistic budget. You need to establish what amount monthly you can steadily pay toward paying down your debt, regardless of the debt management method you choose. And ideally, your financial plan will have the flexibility so you can handle minor emergencies, big unexpected bills, and everything else life tends to throw at us at the worst possible time. This is why setting aside just $5 a paycheck is a meaningful start to establishing an emergency fund; the goal is for you to be able to cover the occasional unplanned car expense or medical bill, as you’re paying down your debt. So work on creating a detailed budget that not only covers your basic living expenses and debt repayment but that also leaves realistic room for surprise expenses as well as building up savings.

This budgeting process will help you to determine exactly how much you feel can dedicate to debt repayment and may make a difference when choosing which option suits you best.

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The Difference Between Debt Consolidation and Debt Settlement

Now you are ready to decide which method is likely to work the best for your situation.

Debt Consolidation

Imagine your debts as a puzzle: The pieces may seem scattered and overwhelming. You may feel as if your current situation is unsolvable. Take a deep breath and move ahead: Debt consolidation might help you put the pieces together. At its simplest, it involves merging multiple debts into one manageable monthly payment. This not only simplifies your financial life but hopefully often comes with a lower interest rate or perhaps an extended term. The latter can lower your monthly payment, though you may pay more in interest over the life of the loan.

The Benefits of Debt Consolidation

Consider these upsides:

Streamlined Finances. No more juggling multiple due dates and varying interest rates. Debt consolidation combines your debt into a single, more straightforward (and easily remembered) payment.

Potential for Lower Interest Rates. By bundling your debts, you may secure a lower interest rate, ultimately reducing the total amount you need to repay. That can be significant.

Preservation of Credit Score. Since you’re actively managing your debts, your credit score should remain relatively stable and slowly improve over time. If you already have a credit score that is high enough to make you eligible for a consolidation loan, this may be a priority.

The Downside of Debt Consolidation

Now, the “watch-out” when it comes to debt consolidation: With only one major payment on your credit report instead of several, you risk its having a larger impact if you miss a payment.

“Missing payments on a debt consolidation loan—or any loan—can cause major damage to your credit score; it may also subject you to added fees.”


What to Do if You’re Denied a Consolidation Loan

If your application for a consolidation loan is denied, don’t panic. Consider alternative methods, such as debt settlement or contacting a credit counseling agency.

Debt Settlement

Debt settlement is a different approach compared to debt consolidation. It’s like negotiating your way through the financial storm. Here, the focus is on reducing the total amount owed by negotiating with creditors. It’s a strategic approach that aims to settle for less than the full balance and slowly knock debts off your list entirely.

The Benefits of Debt Settlement

Here are the pros to taking the debt settlement path:

Potential for Debt Reduction. Most debt settlement programs lead to savings on the total debts owed, as each debt is negotiated with the express intent of reducing the balance. Creditors will consider settling for less than the total owed if they believe they are unlikely to receive full repayment. Typically, you declare you are suffering a financial hardship, and cease making payments on your debts, in order to prime the creditors to consider a settlement.

Monthly Payment Relief. In a debt settlement program, your financial consultant will work with you to figure out a monthly payment you can handle, which can provide immediate relief in some cases. If you are attempting to negotiate with your creditors yourself, you will still be managing all your existing monthly payments on your own.

The Downside of Debt Settlement

Yes, you guessed it: There’s a negative along with the benefits: Debt settlement will have an initial negative impact on your credit score, as you stop payments to your creditors. This impact can be severe, especially if you have been missing payments. This dip is a strategic step, however, as non-payment of debts is what primes creditors to consider settlements. Once you have secured settlements or payment plans with the majority of your creditors, your credit score will begin to recover.

If you are poised to go shopping for a mortgage or a car loan, you will not want to pursue debt settlement. But remember: a high credit score isn’t the only thing that helps you secure favorable loan terms. Your debt-to-income ratio (DTI) and your credit utilization rate are both key factors in how lenders decide whether you can take on more debt. If you are already over-extended, having a solid credit score will not automatically grant you the ability to take on more credit/debt. Paying off your debts is the best way to build long-term financial stability and a strong credit score.

Be Prepared Before Negotiating With Creditors

It is possible to do DYI debt settlement, in which you opt to call and negotiate with your creditors yourself. But timing is of paramount importance: if you have already missed several payments, it’s possible that your creditor will have written off the debt and sold it to a debt collection agency or other recovery institution. Ideally, you would reach out to the creditor when they are still holding your debt. You simply call and express that you are experiencing financial hardship, having difficulty paying your bills, and are hoping to work out a payment plan that you can handle.

But remember: creditors have no requirement to negotiate down your payment and can choose instead to pursue full repayment through the courts. So this approach is best done when you are truly suffering a financial hardship, from a loss of employment or a long-term illness that created significant medical debt, for example.

Pick the Best Debt to Approach First. In general, you will want to attempt a negotiation for your largest debts, both to create payment relief and to keep the creditor from suing you for the owed balances.

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Understand Creditor Motivations. Gain insight into what motivates creditors to settle debts. Often, they prefer receiving a partial payment rather than risking non-payment. Search online to find out what others are saying about the particular company’s approach and what they usually offer.

Review and Confirm Settlement Agreements in Writing. Once a settlement is reached, ensure that all terms are clearly outlined in writing (never act on simply what is said on a phone call). Confirm the agreement with the creditor and read it over to make sure the fine print matches the promises.

Ready to Get Rid of Your Debt?

Remember that there’s no one-size-fits-all solution, and that’s why it is important to recognize the difference between debt consolidation and debt settlement. Your financial well-being is as unique as you are, and the path you choose should line up with your current financial situation as well as your long-term financial goals. Whichever path you take, being proactive about paying down what you owe is a guaranteed step toward financial stability and peace of mind.

Catherine Marucci
Another Second Opinion