How to Choose Between Debt Relief vs. Debt Consolidation

Debt relief is a catch-all term that refers to various strategies for managing and eliminating debt. Debt consolidation is a common strategy that involves simplifying various debts into a single loan, ideally with a lower interest rate. Other debt relief strategies, such as debt settlement, are also worth considering.

Below, we’ll review some of these other forms of debt relief vs. consolidation. Some of the forms of debt relief include debt settlement options, designed for people facing true financial hardship, as well as debt management plans and even bankruptcy. Beyond these options and debt consolidation, you can also consider debt payoff strategies, such as the snowball and avalanche methods.

Debt settlement vs. consolidation: What’s the difference?

Debt settlement and debt consolidation are two distinct approaches to managing debt, each with unique benefits and drawbacks. 

Debt consolidation combines multiple debts into one new loan with a single monthly payment, often at a lower interest rate. It can make managing debt easier and, in some cases, reduce the amount of interest paid over time. Consolidation doesn’t reduce the original debt amount but aims to simplify and lower monthly payments.

Debt settlement negotiates with creditors to accept a reduced balance on a debt, offering potential relief from the total owed. This approach can significantly lower debt if your creditors agree, but it may affect your credit score and can involve fees. 

Settlement is best for individuals who cannot manage payments and need to negotiate relief rather than just streamline their debt.

Detail	Consolidation	Settlement
Objective	Simplify and reduce monthly payments	Reduce total debt balance
Credit impact	Minimal if payments are on time	Potentially negative
Debt reduction	No, only streamlines and potentially lowers interest	Yes, negotiates to lower the amount owed
Payment structure	Single monthly payment for new loan	One-time or lump-sum payment for settled amount
Best for	Individuals with multiple debts seeking simplicity	Individuals in financial hardship needing debt reduction

What is debt settlement?

Debt settlement is a form of debt relief where a borrower negotiates with creditors to reduce the outstanding balance of a debt, aiming to pay back a portion of what’s owed rather than the full amount. Unlike debt consolidation, which combines multiple debts into a new loan for easier management, debt settlement focuses on reducing the principal balance of specific debts. This can provide significant financial relief, but it may also affect credit scores and involve fees.

Debt settlement involves a series of steps: identifying which debts may be eligible, negotiating with creditors to reach an agreed-upon reduced amount, and then making a lump-sum payment or a series of payments to settle the debt. 

Many people work with a debt settlement company, though this isn’t necessary, and creditors may be more inclined to negotiate directly with borrowers facing documented hardship.

How do you negotiate a debt settlement?

Negotiating debt settlement involves strategy and preparation:

1. Evaluate debts: Focus on unsecured debts (for example, credit cards or medical bills), which tend to be more negotiable.
2. Prepare hardship documentation: Providing proof of financial difficulties, such as a recent loss of income, can support your negotiation.
3. Make an initial low offer: Creditors expect negotiations, so starting with an offer of 30% to 50% of the debt can allow room for compromise.
4. Request terms in writing: Once you’ve reached an agreement, confirm the terms in writing to ensure clarity and protect against any future claims.

Pros and cons of debt settlement

Pros

• Debt reduction

  Settling debt can significantly reduce what you owe, freeing up finances for other expenses.

• Faster debt resolution

  A successful settlement can help borrowers resolve debt faster than long-term payment plans.

• Alternative to bankruptcy

  For some, debt settlement offers relief without the long-lasting impact of bankruptcy.

Cons

• Credit impact

  Settling debt can damage credit scores because it reflects that the full debt wasn’t repaid.

• Possible fees

  Debt settlement companies may charge substantial fees, adding to the overall cost.

• Uncertain success

  Creditors aren’t obligated to accept settlement offers, and multiple attempts may be required.

Debt settlement can be a useful option for those struggling with high unsecured debts and ineligible for debt consolidation. However, it’s important to understand the benefits and the potential downsides.

Another possible con is after you settle a debt of $600 or more, the creditor will send out a form 1099-C the January after your settlement closes. The 1099-C tax form reports the amount of debt it cancelled or forgave, which becomes taxable income.

Eric Kirste, CFP®

What is debt consolidation?

Debt consolidation is a debt management strategy where a borrower combines multiple debts into a single new loan, ideally with a lower interest rate. This approach simplifies debt repayment by reducing the number of monthly payments and may help reduce the overall interest burden. 

Unlike debt settlement, which focuses on negotiating and reducing the debt amount, debt consolidation keeps the debt principal intact but aims to make it easier and often cheaper to pay off over time.

Debt consolidation works by paying off your debts with the new loan, leaving one consolidated debt to manage. This approach is popular for unsecured debts, such as credit cards, because it helps streamline payments and often reduces monthly costs.

Forms of debt consolidation

The various types of debt consolidation methods are suited to different financial situations:

1. Personal loans: Many borrowers take out personal loans to consolidate debt, repaying high-interest debts with a single fixed-rate loan.
2. Balance transfer credit cards: For credit card debt, balance transfer cards offer a low- or zero-interest period, allowing borrowers to transfer and pay down balances at little or no interest for a set time.
3. Home equity loans and lines of credit (HELOCs): Homeowners can use the equity in their home to consolidate debts, but this approach uses the home as collateral and comes with certain risks if repayment issues arise.
4. Debt consolidation programs: Some nonprofit organizations offer debt management plans where they negotiate lower interest rates with creditors, consolidating multiple payments into one monthly program payment.

Pros and cons of debt consolidation

Pros

• Simplified payments

  Consolidation replaces multiple payments with a single monthly payment, making it easier to manage.

• Lower interest costs

  Many consolidation options offer lower interest rates, reducing the total cost of debt.

• Fixed payoff timeline

  Personal loans and structured repayment plans provide a set term, helping borrowers plan for a clear end to their debt.

Cons

• Risk of higher costs

  Some consolidation methods, such as balance transfers, may have fees or higher long-term interest rates if the promotional period ends without full repayment.

• Potential for more debt

  Consolidating debt without adjusting spending habits may lead to further debt accumulation.

• Collateral risks

  Secured loans, such as home equity financing, put your assets at risk if you have trouble repaying.

Debt consolidation can be a practical option for those looking to simplify debt management and reduce interest. However, it’s most effective when paired with disciplined spending habits to prevent new debt from accumulating.

How to choose between debt consolidation and debt settlement

Debt consolidation loans tend to be easier to qualify for, but they don’t wipe out your debt; you’re still on the hook for everything you borrowed. Debt settlement, on the other hand, can be challenging to negotiate, and you may need to pay a professional to help, but you can wipe out huge chunks of your debt if successful.

When I work with clients on debt consolidation versus settlement, we focus on debt consolidation as the primary choice. This allows the individual to simplify their debt situation with a single payment, most likely getting a lower rate. Consolidation will help or preserve your credit. 

We often suggest debt settlement as a last resort. This will alter the amount you owe, but the cons listed above and the impact on one’s credit score are damaging. For estates, we often recommend that the executors of the estate settle the debt that their loved one owes.

Eric Kirste, CFP®

So, how do you know which debt relief strategy is right for you? Here are scenarios to consider:

If…	Consider…
You have a good credit score or better	Debt consolidation
You have poor credit	Debt settlement
You can afford your debt if monthly payments go down	Debt consolidation
You are facing true financial hardship and can’t afford your debt	Debt settlement

When to consider debt consolidation

Debt consolidation makes sense in the following scenarios:

You have a good credit score or better

If your credit score is in decent shape, you should be able to qualify for a debt consolidation loan or balance transfer credit card with a competitive interest rate. And if the terms on the loan are flexible, you can request a longer loan term to keep monthly payments down.

Another reason to go the debt consolidation route? Preserving your good credit score. Debt settlement may wipe out large portions of your debt, but it also shows up on your credit report. And because that’s a red flag to lenders, your credit score will drop.

Have fair credit? You can likely still qualify for a personal loan to consolidate your debt, though your options will be more limited, and rates and fees may be higher. Check out the best personal loans for borrowers with fair credit.

You can afford your debt if monthly payments go down

Whenever you can afford to pay your debt instead of settling it, you should. Debt settlement has a major impact on your credit score, and you may owe taxes on the forgiven amount. Plus, you may need the money on hand to pay a lump sum and eliminate the debt.

Debt consolidation, on the other hand, means getting rid of your various high-interest debts and instead paying one single, ideally lower-interest, loan. If you extend the loan term for several years, you can keep your monthly payments low.

When to consider debt settlement

Sometimes, debt settlement is the better path forward. These are scenarios where that might be the case:

You have poor credit

One of the core reasons to avoid debt settlement is the damage it can do to your credit score. But if you already have bad credit—and you’re drowning in debt with no way out—settling your debt might be worth the additional damage to your credit score.

But before you proceed with debt settlement, weigh whether a debt consolidation loan for bad credit makes more sense.

You are facing true financial hardship and can’t afford your debt

Debt settlement is designed for people who truly can’t afford their debt—and are able to prove it. If you are living paycheck to paycheck, only spend money on the essentials, and are working hard to pay down your debt without success, you’ll have a good chance of qualifying for debt settlement.

Just remember: Creditors aren’t obligated to agree to settle your debt. To improve your chances, you need to make a solid case for debt settlement with evidence to back up your financial hardship.

Do you need a professional to handle your debt relief?

You don’t need a professional to help you get a debt consolidation loan. Just research the best personal loans you can qualify for, compare rates, terms, and fees, apply for the best option, and use the cash to pay off your outstanding debts. Some personal loan companies will even pay your creditors directly for you.

If you’re going the debt settlement route, you may benefit from working with a professional. Just note: While these professionals are better equipped to negotiate your debts, they do not guarantee success—and you’re on the hook for paying the fees either way.

Professional settlement companies are also helpful if you can’t afford the lump-sum payment you owe to settle your debt. In that case, the settlement company pays the lenders on your behalf, and then you’ll pay the settlement company.

Proceed with caution: The Federal Trade Commission, Consumer Financial Protection Bureau, and National Foundation for Credit Counseling all advise against for-profit debt settlement companies.

How to identify reputable debt relief companies

If you determine you need a debt relief company to help you settle your debt, make sure you’re working with a reputable company. Here are our tips to ensure the company is legitimate and has a good reputation:

• Read independent reviews: Use websites such as Trustpilot and the Better Business Bureau to see what other people say about working with these companies.
• Look for transparency: A good debt relief company will be transparent about fees and timelines before you sign on the dotted line.
• Check the American Association for Debt Resolution: Formerly known as the American Fair Credit Counsel, the American Association for Debt Resolution serves as a government watchdog for debt relief companies.

You can also find professionals who can help you out even if you aren’t seeking settlement. Financial coaches and advisors, for instance, can help you formulate a plan to pay down your debt or consolidate your debt with a loan.

Other debt relief options

In addition to debt settlement and consolidation, other debt relief strategies may suit different financial needs and goals:

• Debt management plans (DMPs): Offered by nonprofit credit counseling agencies, DMPs help individuals negotiate lower interest rates and combine unsecured debts into one monthly payment. This structured plan typically spans three to five years and works best for those with a steady income who need help organizing and paying off high-interest debt.
• Debt avalanche or snowball methods: These self-guided methods focus on paying down debt strategically without new loans or third-party help. The debt avalanche method targets high-interest debt first to reduce overall costs, and the snowball method pays off the smallest balances first for motivational gains. These are ideal for borrowers seeking a disciplined, independent approach to eliminating debt.
• Bankruptcy: As a last resort, bankruptcy can discharge certain types of debt or establish a manageable repayment plan, providing a fresh financial start. However, it has long-term impacts on credit and may require assets to be sold. Bankruptcy is best for those with overwhelming debt who have exhausted other options.

Each of these methods provides unique benefits depending on an individual’s financial situation, tolerance for risk, and long-term goals.