Debt consolidation is when you lump several unsecured debts into a new loan or credit card, ideally with a lower interest rate. Debt settlement is when you or a third-party company negotiate an agreement with a creditor to pay less than you owe. While debt settlement can reduce the amount you repay, it’s typically riskier than debt consolidation.
What is debt consolidation?
Debt consolidation is the process of rolling multiple unsecured debts, like credit card balances, into a new credit card or loan. You’re left with one payment that can be easier to manage than juggling multiple bills. This new type of credit should charge less interest than your current debts, which saves money and helps you get out of debt faster.
There are several ways to consolidate debt, but balance transfer credit cards and debt consolidation loans are two common options.
Balance transfer cards are best for credit card debt, but you usually need good credit (a score of 690 or higher) to qualify. By transferring credit card balances to a 0% balance transfer card, you can pay off debt for no interest during the promotional period — typically a year or more — though there’s usually a fee of 3% to 5% of the amount transferred. After that, you’ll pay the regular annual percentage rate.
» COMPARE: Best balance transfer credit cards
Debt consolidation loans can pay off a mix of unsecured debts, including credit cards, and are available at banks, credit unions and online lenders. You apply the money from the loan to your debts, then pay back the loan over two to seven years with fixed interest.
Borrowers across the credit spectrum can apply for a consolidation loan. However, borrowers with bad credit (scores of 629 or lower) can expect to pay higher rates and fees. That could defeat the purpose of debt consolidation, since the goal is usually to reduce your interest rate.
» COMPARE: Best debt consolidation loans
What is debt settlement?
Debt settlement is when you settle a debt for less than what you owe, usually with the help of a for-profit debt settlement company.
A debt settlement company will advise you to stop making payments on your debts and funnel the money into an escrow account. As your debt grows more delinquent, the company negotiates with the creditor to accept a smaller amount. The hope is that the creditor figures a lesser payment is better than none.
Most debt settlement companies charge a fee of 15% to 25% of the amount you owe for each successful settlement.
But debt settlement comes with big downsides: Missing payments typically tanks your credit score, and you’ll continue accruing interest and fees while your account is delinquent. Some creditors refuse to work with settlement companies and may even sue you over the unpaid debt.
» MORE: Is debt settlement a good idea?
Debt consolidation vs. debt settlement
If you’re comparing debt consolidation vs. debt settlement, consider the costs, credit score impact and other risks.
Debt consolidation | Debt settlement | |
|---|---|---|
Best if you | Qualify for a lower APR on your unsecured debts. | Can’t afford your unsecured debt payments. |
Credit score impact | Slightly negative in the short term (due to the hard credit check), but often positive in the long term. | Missing payments and settling debts can hurt your credit score. |
Cost | Debt consolidation loan: Interest, plus origination fee of up to 10%. Balance-transfer credit card: 3% to 5% transfer fee, plus interest on remaining balance when 0% APR ends. | Settlement fee ranging from 15% to 25% of the amount owed. Other fees may apply. |
Timeline | One to seven years. | Varies, but can take up to four years. |
Other risks |
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When to consider debt consolidation
- You have credit card debt or a mix of unsecured debts. Debt consolidation is a good fit for unsecured debts, especially credit cards, since they tend to have high interest rates. Secured debts like auto loans are tied to collateral, and rates tend to be lower, so you won’t save as much on interest. Some lenders may have restrictions about using a consolidation loan to pay off secured debts.
- You can qualify for a low enough rate. Debt consolidation makes the most sense when you can qualify for a 0% balance transfer credit card or a consolidation loan with a lower annual percentage rate than your current debts. Borrowers with fair or bad credit may have fewer options, but there are debt consolidation loans for bad credit.
- You can commit to at least a year of paying down debt. Whether you choose a balance transfer card or a debt consolidation loan, you’re looking at a year or more of making payments on your debt. With a loan, payments can stretch to five years or more. Missing payments can trigger late fees and hurt your credit.
- You’ve fixed any core spending issues. Debt consolidation doesn’t get rid of debt. It just makes it easier to pay off. If you’re still overcharging your credit cards, consolidation won’t help and can even make things worse. For example, if you move your credit card debts onto a balance transfer card, then start charging the newly freed-up cards, you’ll be deeper in debt than before.
When to consider debt settlement
- You have a mix of unsecured debt. Debt settlement companies can settle unsecured debts, like credit cards, medical bills or personal loans. Debt settlement doesn’t address secured debt, like an auto loan or mortgage.
- You’re certain you can’t repay what you owe. It’s better to explore other debt payoff options before hiring a for-profit settlement company. But if you’re sure you can never pay back your debt in full, settlement may offer relief.
- You’re willing to take the credit hit. Missing payments on your debts and settling a debt both hurt your credit score. Still, paying something is better than paying nothing at all, so settlement may be worth the ding to your credit if there’s no alternative.
- You can stomach uncertainty. It may take a few years to successfully settle your debts, and even then, there’s no guarantee your creditors will accept a debt settlement offer. Some creditors may refuse to work with a debt settlement company.
Other ways to get debt relief
Debt consolidation and debt settlement aren’t the only ways to get out of debt. Consider all your options before making a decision.
DIY debt payoff
Depending on the amount of debt, you may be able to address it on your own. There are two main strategies for paying down debt: the avalanche method and the snowball method.
- With the avalanche method, you pay down the debt with the highest interest rate first, then work your way down, applying newly freed-up funds to each consecutive debt.
- With the snowball method, you pay down the smallest debt first, then work your way up, building momentum as you go.
However, if your debts will take more than five years to repay, it’s best to consider other options.
Debt management plans
Nonprofit credit counseling agencies offer debt management plans, which work similarly to debt consolidation by rolling multiple unsecured debts into one with a single monthly payment at a lower interest rate. They typically last three to five years and may come with an initial setup fee and monthly fees, ranging from $20 to $75.
You won’t be able to use your credit cards or open new lines of credit while on a debt management plan.
Bankruptcy
If your debt exceeds 40% of your income and you can’t pay it off within five years, bankruptcy may be an option. Bankruptcy can wipe out unsecured debts or help you enter a repayment plan with better terms. It can also stop debt collection calls, debt lawsuits and wage garnishment. The process is complicated, though, so you’ll want to consult a bankruptcy attorney.
