Debt Relief vs. Personal Loan

If your debt has become unaffordable, looking for solutions is a good step to take. Two popular ways to handle debt are debt relief or debt consolidation with a personal loan. Both options may help you deal with unaffordable debt, but they're very different solutions:

• Debt relief involves negotiating with your creditor to accept less than you owe and forgive the rest of your debt.

• Consolidating with a personal loan is when you take out a new loan, ideally with a lower interest rate, to pay off multiple existing debts.

Each method can be successful for the right situation, but they're not interchangeable. If you qualify for an affordable personal loan, consolidating debt could be better for your credit. If you can't afford your debt payments, debt settlement could be the better way to get rid of your debt.

Let's look at each strategy, how they compare, and when to use one over the other.

What Is a Personal Loan for Debt?

A personal loan for debt consolidation is usually an unsecured, fixed-rate installment loan. 

• Unsecured means you don't have to put up collateral, or something of value that you own that backs the loan.

• Fixed-rate means your interest rate won't change for the life of the loan (unlike most credit card rates).

• Installment means you repay your balance with monthly payments over the loan's term—for instance, a five-year loan would mean a total of 60 monthly payments.

If you use a personal loan to pay off multiple existing debts, you're consolidating those debts. This strategy works best when the new loan has a lower interest rate than you're paying on average now. That usually means you need at least fair credit, though higher credit scores could get you lower rates.

The idea is to pay less interest so you can direct more money toward zeroing your balances. Consolidation may also make your debt easier to manage because you're only dealing with one payment that won't change every month. Most personal loan terms last two to six years.

Personal loan payments may be higher than your credit card minimums. That's because credit card minimums are designed to make the bank money, while loans are designed to be paid off at a set time. You also need to make sure not to run up your credit card balances again after you've paid them off.

What Is Debt Relief?

Debt relief is often used to describe debt settlement, which is when you negotiate with your creditors to settle your debt for less than you owe. You pay an agreed-upon amount, either as a lump sum or as part of a payment plan, and the creditor agrees to forgive the rest of your debt.

You could contact creditors yourself or hire a debt relief company to negotiate for you. When you work with a professional debt relief company, you make a monthly deposit into a special account you own while debt negotiators work with your creditors. You may choose to stop paying certain creditors to increase the amount you can save, and missed payments could hurt your credit.

Most debt relief clients settle their first account in a few months. Completing a full debt relief program could take two to four years depending on your income, the number of accounts, and amount of debt.

You generally need to show financial hardship to qualify for debt relief. This is something that prevents you from affording your debts, like job loss, divorce, or a major illness. However, you don't need good credit to enroll in a debt relief program.

Debt Relief vs. Personal Loan: Key Differences

Debt relief and personal loans are completely different ways to manage debt and ultimately make it go away. Personal loans work by adding new debt that can hopefully be repaid faster, while debt relief involves negotiating your debt down to an affordable level.

Here are a few other ways the two strategies differ:

• Qualification. Personal loans generally require you to have at least fair credit, with higher scores typically getting lower rates. Debt relief, on the other hand, has no credit requirements. Instead, you typically need to show financial hardship. Creditors are willing to accept less than they're owed only when they believe you can't pay in full.

• Total paid. When you consolidate debt with a personal loan, you borrow enough to pay off existing accounts and then repay that loan in full and with interest. With a debt relief plan, you may be able to negotiate a payoff that's significantly less than you owe, depending on your situation. Loans come with loan fees and interest, while debt settlement companies usually charge a percentage of your settled debt.

• Payment structure. When you consolidate debt with a personal loan, you make monthly payments to a lender until the loan is paid off. The amount depends on your loan size, interest rate, and term. When you enroll in a debt settlement plan, you and a consultant come up with a monthly amount you can afford, which you deposit into a special account that you control. 

When a Personal Loan Could Make Sense

Personal loans can be the right choice when you qualify for better terms than your existing accounts. 

• You might take a loan with a lower interest rate, which frees up more money to pay off your debt faster.

• Or you might choose a longer repayment term to get a lower payment. Extending your repayment increases your total loan cost, but it could make your debt more affordable. 

• Personal loans usually have fixed interest rates and payments, which makes budgeting easier. 

• Consolidating several accounts with one loan simplifies your life because there’s only one payment to track and make each month. 

The right personal loan could help you pay less interest, clear your debts faster, and/or lower your monthly payment. The average interest rate for a 24-month personal loan runs about 10 percentage points lower than average credit card rates, according to Federal Reserve data, and if your credit is excellent, you might save some real money.   

When a personal loan might not be the best debt solution

Personal loans may not be helpful if you can't qualify for an affordable loan with better terms than you have now. This might be the case if your credit could use work or if you have too much existing debt.

Simply getting approved for a personal loan usually requires fair credit (a credit score over 580). A competitive interest rate might require even better credit. And your loan size will depend a lot on your credit history, income, and how much debt you already have.

Even if you get a good rate, a personal loan payment may be higher than your credit card minimums, because credit card minimum payments are often much smaller than those of installment loans. Make sure that you can comfortably afford any loan before borrowing. 

When Debt Relief Could Be the Better Fit

Sometimes, debt can be unaffordable even if the interest rate goes to zero. Jobs get lost. People become sick. Businesses lose customers. Families break up. 

If you're enduring a financial hardship and already missing payments, your credit score probably isn’t high enough to qualify for a personal loan with a low rate. However, that hardship may convince your creditors to give you a break, accept less than you owe, and help you move forward. That's where debt settlement might be appropriate.

When debt relief might not be the right path forward

Debt relief sounds great because you could get rid of your debt for less than you owe. But it's not a walk in the park. It's a serious decision.

Debt relief is designed for people undergoing financial hardship who are dealing with unmanageable debt they have no hope to repay in full. It's a hard battle that requires time and sacrifice. Your credit will very likely be damaged by missed payments, and creditors or debt collectors may hound you while you're in negotiations.

Debt settlement is not intended for people who can afford their debts. If your income and credit allow you to qualify for an affordable consolidation loan, that's probably a much smoother road and the right choice, even if you have to pay your debts and interest in full. 

How Each Option Affects Your Credit

Personal loans and debt relief have immediate and long-term effects on your credit. Here's how they stack up.

Personal loans: When you apply for a personal loan, you generate a hard inquiry on your credit report and that could drop your credit score by a handful of points. But zeroing out your revolving credit card debt and replacing it with installment debt decreases your credit utilization, which could actually boost your score. Plus, on-time loan payments could help your score grow over the long-term, too. 

Debt relief: The impact of debt relief on your score will really depend on the state of your credit when you start the process. Missed payments generally do a lot of credit score damage. If you choose to stop making payments to your creditors while you save up for settlement, then your credit score could suffer. However, if you're already behind on your payments when you enroll in the program, more missed payments might not have much impact on your score. Rebuilding credit is often easier after debt relief when you're not struggling with unaffordable debt.

Freedom Debt Relief is not a credit repair organization and does not provide or offer services or advice to repair, modify, or improve your credit.

Questions to Ask Yourself Before Choosing Between Debt Relief or a Personal Loan for Debt Consolidation

The debt relief or personal loan decision depends to some extent on lenders. If you can't find a loan with terms that make your debt more affordable, that option isn't on the table. So try prequalifying with a few lenders to learn what your options are. (Do this only with lenders that offer risk-free prequalification that won't generate a hard credit inquiry.) Then, review any offers you get to find out if they'll accomplish your goal. 

Consider these questions when looking at your options:

• Can you qualify for a personal loan with a better interest rate or lower payment?

• Can you afford the monthly payment on a new loan without causing financial strain?

• Are you current on your payments, or have you already fallen behind?

• Do you need to reduce the total amount you owe, or just simplify your payments?

If it looks like consolidation is too little, too late, it might be time to consider debt relief through debt settlement.

How to Get Started With Debt Relief

The first step is to see if you're a good candidate for debt settlement. You can do this through a free evaluation with a professional debt consultant at a debt relief company. The consultant will assess your finances and determine if you're a good fit. 

If debt relief is a workable solution, you'll work out with your consultant how much you can afford to save each month. While you're building your debt relief savings, experienced debt negotiators will contact creditors and work toward settling your balances one by one. 

You'll be notified every time there's a new settlement offer. If you agree with the terms, you authorize payment, your creditor forgives the remaining balance, and you're free of that debt. This process repeats with every enrolled account until you graduate from the program.