Telling It Straight: Debt Consolidation vs. Debt Settlement


Here at ReadyForZero, we’re all about empowering people by helping them create a debt payoff plan and keeping them motivated along the way. However, there are times when it takes a little more than a payoff plan to get out of debt. In fact, a good starting point often happens before the plan.

Why before? Because there could be ways to optimize your financial picture before you get started on a long-term payoff plan. And there may even be times when a debt payoff plan just won’t be good enough for your situation.

In these cases, debt consolidation and debt settlement may cross your mind. But how can you know which is the better option – or if either option will help you?

Debt Consolidation and Debt Settlement Defined

First of all, let’s discuss what each of these terms means. While the definitions themselves are clear, the way some companies market these options can lead to confusion as to what you’re really getting into.

Debt Consolidation

Debt consolidation is the act of combining one or more debt accounts into one (most beneficial if done at a lower interest rate).

Many companies want you to believe that debt consolidation isn’t quite so simple. They want you to believe that you need them to consolidate your debt. This just isn’t the case. You can seek out a company to help you or you can do it on your own through a balance transfer credit card, home equity loan, unsecured loan through your bank or credit union, or peer to peer lender.

And if you try to search for a “debt consolidation company”, chances are they are really a debt settlement or debt management company.

Debt Settlement

Debt settlement is the act of you and your lender agreeing to settle a debt for lower than the amount currently due.

This is another thing that companies would lead you to believe that you need them for. Again, you don’t. You can choose to negotiate a debt settlement with your lenders on your own or you can seek out help from a debt settlement company. The choice is yours.

Deciding if Debt Consolidation or Debt Settlement is Right for You

Deciding if you should pursue debt consolidation or debt settlement will depend largely on the current state of your finances. Debt consolidation can be a good first step, while debt settlement is best used as a last resort.

How to Decide if You Should Consolidate Your Debt
Debt consolidation is a great first step towards optimizing your debt payoff plan. Here’s when you should consider debt consolidation:

  • You’re paying on one more debt accounts that have very high interest rates (such as most credit cards)
  • You’re paying on multiple debt accounts and you’re struggling to keep track of them all

Debt consolidation ends up being most useful for credit card debt* since most credit cards come with high interest rates. If you can combine all into one, that’s ideal. But even if you can lower the interest rate on one of your credit cards, then you’ll be able to ensure more of your monthly payment goes straight to that principal balance.

Once you consolidate your debt, create a targeted payoff plan to ensure that you’re paying off all of your debt as efficiently as possible.

*For student loans and mortgages, you may want to consider different ways to lower your interest rate. A mortgage can be refinanced at a lower rate if you’re current on your payments and have a decent credit score. Student loans have special refinance and consolidation options, but federal loans will lose many of their benefits if consolidated as a private loan.

When Debt Consolidation May Not Work for You
Debt consolidation is a great tool to lower your interest rate and use that as a way to decrease your repayment time. It’s also useful if you’re struggling to pay your current monthly payments.

However, since debt consolidation happens through the acquisition of a new loan or line of credit, it will not work if your credit score is too low to be approved for the new credit. If you can’t make your monthly payments and you won’t be approved for new credit, then it might be time to take a harder look at your debt situation.

How to Decide if You Should Settle Your Debt
Where debt consolidation is a great first step towards debt payoff, debt settlement is more of a last resort. In fact, it’s a strategy some people take to avoid bankruptcy (though recent studies show that debt settlement can lead to bankruptcy). This might be something to consider if:

  • Your credit score is not high enough for you to be approved for a debt consolidation loan or line of credit
  • You are seriously behind on payments
  • You have money set aside (or you can set money aside) to be used for the settlement

When Debt Settlement May Not Work for You
Settling your debt requires you to either have money to settle the debt with (unless you can go into a hardship program and save money in the interim for the settlement) or to go to a debt settlement company that puts your monthly payments in escrow for you to settle later.

Both scenarios require money that you may not have (depending on how deeply you are struggling) and the latter can seriously damage your credit score. If you’re not able to make monthly payments at all, debt settlement may not work for you. You might then need to consider bankruptcy. Bankruptcy also affects your credit, but gives those who cannot see any way to reasonably pay off their debt a chance to start fresh.

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The Only Way to Pay Off Debt for Good

Debt can happen for so many reasons: emergencies, difficult circumstances, investments in the future (such as a mortgage or student loans), a lack of budgeting, and more. And depending on the circumstances, you may find that you need more help paying it off through tools like debt consolidation, debt settlement, or maybe even bankruptcy. But no matter what, changing the way you view money, debt, and credit is what you’ll need to do to avoid debt in the future.

For example, if you build an emergency fund, create a budget, and view money as a tool that can work for you rather than the other way around, then you’ll build a solid foundation to start from. Let’s face it, personal finance management isn’t taught in schools and common belief is that earning more money is the only way to reach financial success.

It’s not. People of all situations and incomes face debt. Those who reach success paying debt off flip their money script. They realize that it takes time and that there are no easy ways out. They realize that they have more control than they ever thought they did, they create a plan, and they change their lifestyle to prevent the ongoing cycle of debt.

No matter the reason you got into debt, no matter your income, no matter your past, and no matter your present, you can create a life of debt freedom. The power is in your hands – you just need to grab it!

Image Credit: friedpickles

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  • Thanks for the post, Shannon! As you point out, it’s important to understand the differences and the different ramifications of each option.

    I would add a couple of opinions. One: with true debt consolidation, I highly recommend against it when the debt is the result of consumer spending. 70% of those who use home equity to pay off their credit card debt (although it seems logical given the lower interest rates and the tax benefits) typically spend themselves right back into the same credit card debt within 1-2 years… plus they now have home equity debt. The primary problem is not the debt but the spending in such cases.

    Also, I would add, between debt consolidation and debt settlement, a visit to a nonprofit credit counseling agency (CCA) who is a member of one of the main trade associations: AICCCA, NFCC or ACCpros. You certainly CAN negotiate on your own a lower interest rate with a single creditor, but when they find that you have accounts with other creditors, they prefer that you work with a CCA. That’s how they know you’ll work with ALL of your creditors, and they won’t feel like they’re the only one offering the concessions.

    • Shannon_ReadyForZero

      Thanks so much for offering this additional advice, Todd!