Debt Settlement vs. Debt Consolidation: Which Is Right for You?

Are you having trouble keeping up with your debts? With millions of Americans in the same boat, you’re far from alone.

The way to break free from debt struggles is to take action. We’ll help you understand what debt consolidation and debt settlement could do for you.

Debt Consolidation vs. Debt Settlement In a Nutshell

Debt consolidation and debt settlement are different types of debt management. Debt settlement involves negotiating with creditors to reduce your debt. Debt consolidation rearranges the debt without changing how much you owe. 

The right route depends on your loan balance, credit score, status of repayments, and ability to keep on top of your payments. If you're trying to get on top of your debts, start by understanding the options. 

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What Is Debt Consolidation?

Debt consolidation means taking out a new loan and using it to pay off multiple existing debts. One benefit is that you could reduce the number of payments you make each month. This could make it easier to keep track of compared to multiple payments to different creditors. 

Beyond that, debt consolidation has several advantages. Even getting one or two of these benefits could make the strategy worthwhile:

• Lower your monthly payments, relieving strain on your budget

• Lower the interest rate you're paying

• Get a firm payoff date for the debt you consolidate

• ​​Lower your credit utilization ratio and potentially increase your credit score if you use a new installment loan to reduce your credit card debt

• Move variable-rate debt to a fixed interest rate

• Reduce the total amount of interest you pay (unless you take longer to pay off the loan)

Debt consolidation works if your credit is still good enough for you to qualify for a new loan. It’s not a realistic option if you’ve already fallen behind on your payments. 

When Should You Consider Debt Consolidation?

Debt consolidation makes the most sense when:

• You move high-interest debts, like credit cards, to a new, lower-interest loan

• You have a plan for managing new debt

• You can afford your debts but want to streamline them

Whenever you have debt, it’s smart to be on the lookout for ways to make it cheaper and easier to manage. You could consider debt consolidation if you qualify for a new loan that has better terms than your existing debt and you have a plan to avoid running other debts back up. 

For instance, if your debt was caused by overspending, be proactive about shutting down or freezing your credit cards, especially while you’re paying down your consolidation loan. Debt consolidation only works as part of a debt repayment plan. Otherwise, you risk opening the way to even more debt. 

On the other hand, if your debt was caused by a medical emergency, you might not be at risk of overspending.

For example, let's say you qualify for a personal loan with a lower APR than your credit cards. You use it to pay off your balances, but you still don't have enough cash to cover your everyday expenses. There's a danger you wind up using your cards and owing that money in addition to your debt consolidation loan.

Running up the balances on paid-off credit cards is a common risk factor with debt consolidation. Be aware of it and have a plan to avoid increasing your debt.

What Is Debt Settlement?

Debt settlement means negotiating with creditors to reduce the amount of your debts. You can do this yourself or hire a debt settlement professional like Freedom Debt Relief to do it for you.

If you can’t pay your debts, don't ignore them. This will result in bill collectors hounding you while you damage your credit score by missing payments. As interest and fees accumulate, your debts will grow.

The better way is to contact your creditors and try to work something out. You could do this yourself or use professional debt settlement. Creditors would like to be paid all that they’re owed, but they don’t want to waste time trying to collect on debts you might not be able to pay.

If you can demonstrate to a creditor that there’s no way you can pay your debt in full, they might agree to accept a lesser amount. As the saying goes, half a loaf is better than none.

It’s true that debt settlement  will show up on your credit report and impact your credit score for a time. When a debt is reported as “settled,” that’s less favorable than “paid as agreed." 

But once you're back on firm financial footing, you can take steps to rebuild your credit. The key is to get rid of that crushing debt so you can afford to make all your payments on time every month. At that point, you'll be better positioned to build up your credit score. 

When Should You Consider Debt Settlement?

Debt settlement makes the most sense when:

• You’ve already considered other solutions, like tighter budgeting or debt consolidation.

• You have a financial hardship that leaves you no realistic way of fully repaying your debts.

• You’ve already fallen behind or you’re at risk of falling behind.

Debt settlement can be a game-changer when you can’t see any realistic way of paying your debts in full. Consider debt settlement if you’re experiencing a financial hardship that could make it difficult or impossible to fully repay what you owe.

Maybe you’ve tried cutting unnecessary expenses but still can’t make your money stretch far enough to cover your essential costs. Perhaps you’ve considered debt consolidation but found it wouldn't lower your payments enough. Maybe you couldn't qualify for the loan you wanted.

Debt settlement isn't quick or easy. You have to have something to offer your creditors. To save up money for offers, many people choose to stop paying their debts. Any time you stop paying your debts, you should expect a negative impact on your credit standing. Late and missed payments stay on your credit report for seven years. 

Even so, becoming financially stable could put you in a better position to build healthy credit and a better financial future.  

Debt Settlement vs. Debt Consolidation: A Side-By-Side Comparison

Think of debt consolidation and debt settlement as different tools for different situations. Which strategy is better for you depends on your needs and circumstances. Here’s a rundown of some of the key differences between debt consolidation and debt settlement:

Alternatives to Debt Consolidation and Debt Settlement

Debt consolidation and debt settlement aren’t the right debt solutions in every situation. You could also manage your debt by setting up a debt management plan, visiting a credit counselor, declaring bankruptcy, or handling things yourself. 

Here are some other ways to manage overwhelming debt:

• Debt management plan (DMP): You work with a credit counselor to create a plan to pay down your debts. Your counselor then negotiates with creditors on your behalf to try to make your payments manageable. Once it is set up, you make one single monthly payment to the credit counselor, who will split it between your creditors. 

• Credit counseling: Credit counselors can help you lower your payments and organize your budget. You don’t have to set up a debt management plan to work with a credit counselor. 

• Negotiate your own payment plans: You may be able to get yourself some breathing room by speaking directly to creditors. Some creditors may be willing to lower your monthly payment or give you a reduced interest rate, particularly if you are facing temporary hardship like a job loss. 

• Bankruptcy: Bankruptcy is a legal process that takes place in court. You may be able to reorganize your debts or even completely walk away from some of your debts. The two most common types of bankruptcy for individuals are Chapter 7 and Chapter 13.

• Pay off the debt: You could follow a plan to pay off your debts without a program. Debt payoff plans usually require that you make some sacrifices and cut back on spending. But people do it successfully all the time.

Debt Settlement vs. Debt Consolidation: Deciding What Works For You

To decide whether debt settlement, debt consolidation, or another way to manage debt is right for you, take a close look at how each will affect your situation. Think about what you’d most like to accomplish. If your debt feels unmanageable, you may have different goals from someone who wants to pay less credit card interest.

Consider more than just reducing your monthly payments. Factor in the total debt costs, the amount you'd pay in fees, and the impact on your credit score. That way, you can decide which strategy will leave you better off, both now and in the future.