Who Qualifies for Debt Settlement or Consolidation Programs?

Life is full of challenges, and those can sometimes lead to debts that get a bit out of hand. Taking the steps to learn about your options is a smart move toward getting that debt back under control.

When you're researching debt relief options, you'll come across two popular strategies pretty much everywhere: debt consolidation and debt settlement. Under the right circumstances, either could be a good way to get your finances back on track. 

However, settlement and consolidation are very different debt relief strategies—with very different requirements—and one is likely going to be a much better fit for your situation than the other. Let’s look at who qualifies for each type of program so you can decide which is right for you. 

Who Qualifies for Debt Settlement Programs?

Debt settlement programs involve negotiating with creditors to repay less than the total you owe, and forgive the remaining balance. You could do this on your own, or you can hire a professional debt settlement company to negotiate on your behalf.

To qualify for a debt settlement program, you typically need:

• At least $7,500 in unsecured debt. Unsecured debt is not backed by collateral or anything of value, so things like credit card debt, personal loans, payday loans, or medical bills.

• Financial hardship. This is a situation you're dealing with that makes it impossible for you to afford your full balances, such as job loss, death in the family, home repair emergencies, etc.

• The ability to make monthly payments. Debt settlement programs typically have you make a monthly payment into an escrow account you own. This is where the settlement money comes from if a settlement agreement is reached. You'll work out how much you can afford to contribute each month when you enroll in the program.

You don't need good credit to qualify for debt settlement programs. You also don't need a minimum income. Many people choose to stop paying their creditors to save up for settlement, and your monthly settlement contribution may be less than your minimum card payments. 

Missed debt payments may hurt your credit score, but the damage could be less impactful to your scores if you're already behind on your payments. And you can always rebuild your credit once your debt is behind you.

Types of debt that qualify for settlement

Knowing what kind of debt qualifies is a key part of understanding how debt settlement works. Most unsecured debt can be settled. This includes:

• Credit cards

• Store cards 

• Medical bills

• Payday loans

• Personal loans

Secured loans backed by collateral, like mortgages, car loans, and home equity loans, don't usually qualify for settlement. Since these debts are guaranteed by the car or house, lenders don't really have a good reason to work with you to settle the debt—they could just take the asset to get paid. 

If you have federal student loans, those are also usually handled outside of debt settlement, through government programs offering consolidation or rehabilitation. However, student loan forgiveness isn't a type of debt settlement. It's a different process altogether.

Private student loans are more of a gray area. You may be able to settle private student loans, but a lot depends on your situation. Your debt relief company can help you explore your options.

Financial hardship requirements

One of the most frequently asked questions about debt settlement is whether creditors will be willing to work with you.

Typically, creditors are willing to accept a settlement for less than you owe—if they think that otherwise, you won't pay anything or will file for bankruptcy. If you can show that you have financial hardship and can't pay your debt because of it, this could significantly increase your chances of a successful debt settlement. 

Examples of hardship include:

• Job loss

• Illness

• Divorce

• Major home repairs

• Unexpected expenses

You don't necessarily have to have experienced one of these issues, but it helps if there's clear evidence that something prevents you from paying the full amount you owe.

Who Qualifies for Debt Consolidation Loans?

Qualifying for debt consolidation is very different from qualifying for debt settlement. That's because debt consolidation involves getting a new loan—ideally with a lower rate and more affordable payments—to pay off current creditors. You then make monthly loan payments to pay off the loan over time.

The specific qualifications for a consolidation loan will depend on the lender. Generally, though, you'll need to have:

• At least a fair credit score. You usually need fair credit to get a consolidation loan, and either good credit or collateral (something of value you own that backs the loan) to get competitive interest rates.

• An acceptable debt-to-income (DTI) ratio. Lenders won't give you more money if they think you already have too much debt compared to your income. Your DTI is your monthly debt payments (plus housing) divided by your income. Lenders tend to prefer a DTI below 43%, though they may be more flexible if you're getting the loan to consolidate debt.

• Collateral (for secured loans). Personal consolidation loans tend to be unsecured, so you won't need collateral to qualify. However, if you get a secured consolidation loan, such a home equity loan, then the lender will have qualifications for your collateral, too.

The type of debt doesn't necessarily matter for consolidation. You can use a debt consolidation loan to pay off secured or unsecured debt. However, it usually only makes sense to pay off existing loans if the consolidation loan has better terms, such as a lower interest rate. 

Credit score requirements

Credit score requirements for debt consolidation loans vary by lender and loan type. Most lenders want to see at least fair credit (a FICO Score between 580 and 669). Higher scores generally help you qualify with more lenders and at lower rates.

If your score is too low, many lenders won't give you a loan. However, you still have options. You can work with lenders that offer bad credit loans—although those loans may be more expensive. You could also find a co-signer with good credit who agrees to share responsibility for your loan. They commit to paying if you don't, so be sure you can pay back what you borrow. 

Home equity loans may also have more flexible credit requirements than personal loans. That's because these loans are secured by your home. But if you don't pay, you could lose your house, so be sure you can make the monthly payments. 

Income and debt-to-income ratio

Lenders want to be sure you can pay back your debt consolidation loan. They'll likely want to see pay stubs, tax returns, or other proof of income. It's best when you can show your income is steady or increasing year over year. 

They also look at your existing debts. How much you owe in total matters less than how much you owe relative to your income. Lenders use your debt-to-income ratio to measure how affordable your current debt is compared to your income.

Lenders aren't just going to think about the debt you have now—they'll also calculate what your DTI would be if they give you a loan. Since consolidation loans are basically moving your debt around, rather than adding to your total debt, the lender may be more flexible about how your DTI is calculated for the new consolidation loan, especially if you let the lender pay your creditors directly.

Collateral considerations

You don't need to think about collateral if you're getting an unsecured personal loan to consolidate. If you're exploring a home equity loan or home equity line of credit (HELOC), on the other hand, then you're using your home's equity as collateral and will need to meet the lender's loan-to-value (LTV) qualifications.

LTV is a measure of how much you owe on your home loan versus the value of your home. If you owe $150,000 and your home is worth $200,000, your LTV is 75%. Lenders prefer your LTV to be less than 85%, including your home equity loan. If you don't have enough equity, you may not qualify for the size home equity loan you need.

Debt Settlement vs. Consolidation: Key Differences

Whether you’re looking for credit card debt relief or are interested in consolidating other kinds of debt, check out the key differences between debt settlement and debt consolidation:

How to Know Which Program Is Right for You

Debt settlement could be a better fit if:

• You're behind on your payments or struggling to pay the minimum due. 

• You have unsecured debt that can be included in a debt settlement plan.

• You can't qualify for a new loan with better terms to pay off what you owe.

• You’re facing financial hardship that makes paying your full loan balance difficult.

• You want to reduce your total debt, rather than just reorganizing it. 

Consolidation could be a better fit if: 

• You want to simplify the debt repayment process by combining multiple debts into one.

• You have good-enough credit to qualify for a new loan at an affordable rate. 

• You can afford to repay your debt in full—especially if you can reduce your payment through consolidation. 

Still not sure of the right move? Consider getting a free evaluation through Freedom Debt Relief to see if you're a good fit for debt settlement.