The reality about debt is that it’s easy to get into, but difficult to get out of. Depending on the amount of debt you owe and your financial situation, it can take several years before you can eliminate your debt. Your own personal spending habits, as well as your income, also play a key factor in your capacity to pay off what you owe.

Despite what may seem like obstacles, it is entirely possible to manage a large amount of debt. This is where debt settlement or debt consolidation are routinely researched. Let’s look at what differences the two repayment strategies have between them and what option may be right for you.

Debt Settlement vs. Debt Consolidation

Debt settlement and debt consolidation are options that you can consider when you have personal debt, typically when it results in having difficulty repaying it. While these two repayment options employ a different approach, their goal is the same: to help you pay off debt in a way that’s advantageous to your situation. But what’s the difference between debt settlement and debt consolidation?

Debt Settlement

Debt settlement is a strategy where you reach an agreement with your creditors to pay less than the amount you owe. This is usually done when you have cash on hand and can pay off your debt with a lump sum or are able to save for a lump sum payment while ceasing payments to your creditors.

For instance, if your total debt amount is $10,000, you may negotiate with your creditor to pay the debt for a lump sum of $5,000 if they offer a 50% settlement. Typically, accounts must be quite delinquent or nearing a charge off status before these last resort opportunities become available to consumers. The creditor may also agree to a series of installments instead of a lump-sum payment.

Keep in mind that if you have several creditors, you will have to negotiate with each one of them to settle your debt for a lesser amount. If you choose to go this route, it is also important to remember that creditors are not obligated to accept your offer. Some may also refuse to negotiate with you or a debt settlement company.

Pay Off Debt with Highest Interest Rate FirstIf you use an outside company to settle your debt, it’s imperative that you understand the true cost and total savings to you if there are any when everything is settled.

In their examination about the truth about debt settlement, Money Fit notes that after adding the settlement companies fees and possible taxes due, you’ll end up paying 70% to 95% of your original balances, not 50%. That means an original debt of $10,000 could end up only saving you on the high end, $3,500, or just $500 on the low end.

Debt Consolidation

Debt consolidation, on the other hand, is a process where you roll multiple debts into one. Through a consolidated loan or a nonprofit debt management program. We’ll review both types of debt consolidation programs.

Debt Consolidation with a Loan

By consolidating your debts into one loan you will only have one interest rate and one monthly payment to make. Consolidation loans are offered by many financial institutions such as banks, credit unions, and online lenders. Simply put, you will only have to pay one lender instead of multiple lenders when you opt for debt consolidation and ideally, you’ll qualify for a low interest rate.

Consolidation loans may be secured or unsecured. In secured consolidation loans, you will have to put up one of your assets as collateral. For instance, if you take out a home equity loan to consolidate your debt, your home becomes the collateral. This assures the lender that you will pay the debt or else risk losing your collateral.

Nonprofit Debt Management (Debt Consolidation without a Loan)

A popular option that doesn’t require a new loan is enrolling onto a debt management plan with a nonprofit credit counseling organization, like Debt Reduction Services, Inc.

These programs don’t settle the balances of the debt owed. Rather, they focus on creating a smaller monthly payment by consolidating all the debts into one monthly payment under arranged terms with your creditors. These terms focus on reducing the monthly payment, lowering interest rates, and stopping late or over limit fees from accumulating. Typically, debt management plans are paid in full in 5 years or less. The accounts are closed to further charging and when one account is paid off, the amount of that payment is used to pay more towards the remaining debt.

Pros and Cons of Debt Settlement


  • Pay a reduced amount: One advantage of debt settlement is that you get to pay an amount that’s lower than your original debt, provided your creditor agrees to your offer.
  • It’s an alternative to bankruptcy: For those who don’t want to declare bankruptcy, debt settlement can be a short-term solution. If you’re able to negotiate with your creditor and they agree, you can wipe your debt with a lump-sum payment instead of declaring bankruptcy.
  • Suited for late payments: If you’re already behind payments for more than a year and you are at risk of being sued by your creditor, you might be able to negotiate for a debt settlement. This can be less financially damaging than filing for bankruptcy, though there will still be damage to your credit score.


  • Negative impact on credit score: Not being able to pay the full amount of a debt is a negative in your credit score. Further, since debt settlements are typically pursued by those who are late in payments, these late payments also negatively impact your credit score.
  • Negative impact on credit report: Like your credit score, your credit report will also be affected negatively. Your history of debt settlement will remain on your credit report for seven years. This can make it difficult for you to get additional credit from lenders in the future.
  • Penalties: Often, hiring a debt settlement company to perform the negotiations for you will mean that you will have to withhold payments to your creditors. This can rack up additional late fees, interest, and other penalties to the amount you already owe.
  • Additional charges: Further to working with a debt settlement company, you will likely have to pay for their service fees. Typically, these service fees are based on the final amount that has been agreed upon for the debt settlement. The percentage you pay for can be between 20% and 25%.
  • Results are uncertain: As mentioned, your creditors are not obligated to accept settlement offers. Some may even refuse the negotiations altogether, whether you do this personally or through a debt settlement company.
  • Tax consequences: Since you did not pay the full amount for your debt, the IRS might consider the amount forgiven as income, thus incurring taxes.
  • Can be difficult with multiple creditors: While debt settlement can theoretically work with one creditor, negotiating with multiple creditors can be difficult and costly. This is especially true if you’re working with a debt settlement company as they might require you to pay service fees for each debt settlement they will negotiate on your behalf.

Pros and Cons of Debt Consolidation


  • Simplified process: Instead of making multiple separate payments, debt consolidation allows you to pay for all your bills to one lender. You have one monthly deadline instead of having many that you must keep track of separately. Also, with nonprofit debt consolidation programs you can still consolidate your debt, even if you have bad credit.
  • Lower interest rates: Theoretically, your interest rates should be much lower when you opt for debt consolidation. For instance, if you’re late in paying your credit card bills, the card company can raise your interest to about 25% to 30% of your balance. If you get a debt consolidation loan, you will be paying between 8% and 15% interest in most cases.
  • Improved credit score: Paying off all your debt should reflect positively on your credit score.
  • Reduced psychological burden: Often, paying for multiple debts can affect you psychologically. You may feel as though it’s hopeless to wipe everything clean, which can lead to stress and even illness. Debt consolidation eases this burden as you will only have to deal with one payment to one lender each month.


  • Debt is not reduced: While it’s convenient to have all your debts into one consolidated payment, this doesn’t mean that the amount will be reduced. Only the interest rate may potentially be reduced. You still must pay the full amount for your debts.
  • Good credit score is needed when seeking a consolidation loan: Your credit score may be improved through debt consolidation, but to qualify for a consolidation loan, you will need a good credit score to begin with. With a poor credit score, your application for a debt consolidation loan may be denied. Similarly, the interest rate for the consolidation loan might be like the interest rate in your credit cards. For individuals with low credit scores, debt management plans are available.
  • Time frame: The difficulty in managing debt often lies with the time you must spend making repayments. If you opt for debt consolidation, you may have to spend an average of two to five years of making payments.

Which Debt Repayment Strategy Is Right for You?

As with any financial strategy or debt repayment program, you need to first take stock of your overall financial standing before choosing one approach over the other.

financial strategy

In the case of debt settlement, this approach can be risky but perhaps worth pursuing when you have a substantial amount of debt from one lender, are extremely late with payments and are attempting to avoid bankruptcy. It is also more recommended for those who are at risk of being sued by their creditor or those who are significantly behind in their payments.

On the other hand, debt consolidation may be the more affordable and safer route for individuals who are still on time with their balances but don’t want to deal with an overwhelming amount of bills each month. Though debt consolidation will not instantly wipe out your debt, both its pros and cons outweigh the potential issues that can arise from debt settlement.

Be that as it may, whether you choose debt settlement or debt consolidation, make sure that the approach will be advantageous to your personal financial situation. Moreover, make every effort to try to curb your spending and not incur more debt while in the process of making repayments.

Rick Munster, Author
About the Author

Rick has been in the financial and credit counseling industry for over 20 years. He is currently a HUD certified housing counselor and has well over a decade of experience as a certified credit counselor. Rick writes regularly on matters relating to consumer finances and is a contributor for many publications on these topics.