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Debt Consolidation Vs. Debt Settlement: How To Choose

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Debt can feel like an anchor, dragging you down and keeping you from achieving your financial goals. One of the most popular options for dealing with debt is debt consolidation. Effectively, you take out a loan, usually a personal loan, and pay off your debts.

Another popular option is debt settlement, where, either directly or through a third party, you negotiate with your creditors to settle your debt for less than what is owed.

In this article, we’ll explain the differences between these two options, their relative strengths and weaknesses and provide recommendations for when each option might make sense. 

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Debt Consolidation vs. Debt Settlement: Key Differences

Debt consolidation and debt settlement are fundamentally different ways to go about getting out of debt. This table provides a quick overview. We’ll go into more detail below.

Debt ConsolidationDebt Settlement
StructureYou take out a new loan to pay off your existing debts.You negotiate with your creditors to pay less than what you owe on your accounts.
ValuePersonal loans usually range between $2,000 – $45,000.Results vary widely depending on negotiations and how much you owe. It’s possible to have a large portion (50% more) of your debt forgiven.
RequirementsYou need to qualify for the loan: credit score and debt-to-income (DTI) ratio are critical factors.You need to be able to pay the fees and earn enough to make the payments to follow the program.
CostYou’ll owe interest on your monthly payments. There will be an origination fee and fees for late payments.If you use a debt relief company to negotiate for you, fees can range from 15% – 25% of the debt you’re settling.
Credit ImpactWill cause a slight initial dip, but can actually help your score if you make on-time payments.Will hurt your credit score and stay on your credit report for seven years


Here’s more detail on how both debt consolidation and debt settlement are structured.

Debt consolidation

When people refer to debt consolidation loans, they often mean personal loans used to consolidate debt. However, it’s also possible to use other loans for the same purpose, like a home equity loan or a home equity line of credit (HELOC). Because personal loans are a common debt consolidation option, we’ll mainly focus on them throughout the article.

Regardless of the loan type, consolidation loans work by using the new funds to pay off your existing debt. You’re then responsible for paying back the new loan, ideally at a lower interest rate. It can also streamline your monthly payments if you have multiple sources of debt.

Debt settlement

Debt settlement works by negotiating with your creditors. You can either do this directly or by enlisting the help of a third-party company. Debt settlement is a for-profit business, meaning that there are companies that specialize in this type of negotiation. If you use one of these companies, you’ll need to pay them to negotiate on your behalf.

One of the reasons these companies exist is that creditors are not required to negotiate a debt settlement with you. In fact, if the debt is large enough, they could take you to court and sue in an effort to recoup their funds.

Another reason is that if you have multiple sources of debt, you’ll need to come to an agreement with each creditor. This can be a lot to manage individually.


The maximum amount you can take out with a personal loan is usually around $45,000. If you opt for a different type of loan, like a home equity loan, to use for debt consolidation, you could potentially take out more depending on how much equity you’ve built up.

The total value saved with debt settlement will depend on both how much debt you have and how the negotiations go with your creditor. For example, if you owe $10,000 and settle for 75% of what you owe, that would be worth $2,500. If you use a company to help you, their fees will eat into that value.


Personal loans are typically unsecured loans. That means that you don’t need to put down collateral to get one. The lender will decide whether or not to issue you the loan based on the strength or weakness of your application.

Most lenders have minimum credit scores that you’ll need to hit to qualify for a personal loan. They aren’t always publicized but tend to be in the mid-600s, depending on the lender. Your debt to income (DTI) ratio will also be an important factor.

Qualifying for debt settlement is more straightforward. You’ll need to be able to afford the fees and the repayment plan that’s laid out, but there’s no need for a credit pull as you’re trying to resolve debt that has already been accrued.


With a personal loan, you’ll be responsible for paying an origination fee. This is almost always a percentage of the loan value, so the greater the value of the loan, the bigger the fee will be. You’ll also be responsible for paying interest. The combined cost of the lender fees with the interest they charge is known as the annual percentage rate (APR).

Comparing APRs is a good way to get a sense of how much a personal loan will cost with different lenders. You should also ask about prepayment penalties as some lenders will charge an additional fee if you pay off the remaining loan balance early.

The cost of debt settlement is much more variable. It depends on whether you negotiate with the creditors yourself or if you use a company to help you. With a company helping you, you’ll be responsible for paying a company a fee – usually, a percentage of the debt being settled.

There’s also the matter of the repayment program. How much you’ll owe each month will depend on what gets negotiated with the creditors.

Credit Impact

When you take out a debt consolidation loan, your credit will dip temporarily due to the hard credit pull that’s a routine part of the application process. However, if you make your monthly payments on time and in full, you can actually help your credit score over time.

Debt settlement will have a significant negative impact on your credit score. Even if you make all the payments in your program and pay all of the fees, your credit score will still be worse overall for going through the process. Your debt settlement will also stay on your credit report for seven years.

Debt Consolidation vs. Debt Settlement Pros and Cons

When deciding between these two options for debt relief, it’s important to weigh their strengths and weaknesses against each other. We’ve put together pros and cons to review.

Debt consolidation

PROS of debt consolidation👍

Fast approval

If you use a personal loan for debt consolidation, your application can be approved quickly. Some lenders can even do it in as little as 1 business day.

Simplify your finances

If you have multiple sources of debt, replacing them with a debt consolidation loan can condense that to one monthly payment, which will likely be easier to manage.

Could improve your credit score

If you make your payments on time and in full over the loan term, your credit score could increase over time.

CONS of debt consolidation👎

Capped amount

Personal loans are usually capped at around $45,000. So if you have more debt, a debt consolidation loan might not be able to cover what you owe completely.

Harder to qualify

Personal loans are harder to qualify for than debt settlement because of the credit score requirements and the fact lenders will review factors like your DTI ratio.

Could pay more in interest

You’ll owe interest each month as a part of your monthly payment. Over the life of the loan, you could wind up paying more in interest than you would have with debt settlement, especially if a significant amount of what you owed was forgiven.

Debt settlement

PROS of debt settlement👍

Could owe less money

If your creditors agree to a debt settlement, you could end up paying back significantly less than what you owe.

Could pay off debt sooner

Agreeing to a new debt total should allow you to pay it off faster, which means you can be debt-free sooner.

CONS of debt settlement👎

Credit will be damaged

No ifs, ands or buts. Your credit score will take a significant hit with debt settlement. It will also stay on your credit report for seven years.

Fees can be high

If you enlist a company to negotiate with your creditors on your behalf, the fees can be significant, like 25% of what you owe. This will eat into whatever you save by settling.

There’s no guarantee it will work

Creditors are under no obligation to negotiate a debt settlement with you. In fact, if the value of the debt is high enough, they might take you to court in an attempt to unlock more extreme measures, such as wage garnishment or liens on your property.

You’ll also need to negotiate with each creditor you owe. So you could find yourself in a situation where one creditor agrees to terms while another does not.

It can affect your taxes

If a significant amount of your debt gets forgiven, you could owe taxes on it because the Internal Revenue Service (IRS) considers it income.

Which Is Better, Debt Consolidation or Debt Settlement?

Better is a relative term, as each option can be an effective way to reduce debt. That said, there are some situations where debt consolidation may be better suited than debt settlement and vice versa.

When to consider debt consolidation

  • You have good credit: A good credit score will give you better loan terms, which can save you on interest and give you more loan options to choose from.
  • You have multiple sources of debt: Instead of negotiating with multiple creditors, a debt consolidation loan lets you pay all of them back and condenses your debt into one monthly payment.
  • You want to preserve your credit score: Debt settlement will hurt your credit score while managing debt consolidation responsibly can improve your credit over time.

When to consider debt settlement

  • You can’t qualify for a personal loan: It can be difficult to qualify for a debt consolidation loan, especially if you don’t have good credit. This can limit your options.
  • You have too much debt to pay back: Getting a new loan won’t help matters much if you can’t afford the monthly payments on it. In those instances, lowering the amount you owe might be the best place to start.
  • You want to avoid bankruptcy: While debt settlement will damage your credit, it’s still not as bad as bankruptcy. It also won’t stay on your credit report as long as bankruptcy will.

Next Steps for Debt Consolidation

If you’re interested in pursuing debt consolidation, first you’ll need to find a lender. You should take the time to research lenders, get a sense of the loan terms you would receive and compare APRs.

Once you decide on a lender, the next step is to apply for the loan. The approval process can be relatively fast. If you’re approved, some lenders can even issue the funds the same day you apply.

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Next Steps for Debt Settlement

If you’re interested in debt settlement, you need to decide if you want to negotiate with your creditors on your own or if you want to enlist the help of a company.

If you do decide to hire a company, make sure to do your due diligence. There are a lot of scams out there, so beware of companies that guarantee results or promise specific savings before they’ve even spoken with your creditors.

If you don’t want to use a third party, you’ll need to reach out to your creditors to begin negotiating. If you do come to an agreement, make sure that the terms are agreed to in writing with signatures.

Alternative Options for Debt Relief

Debt consolidation and debt settlement aren’t the only tried and true methods for finding debt relief. Here are some other popular options to consider.

The avalanche or snowball methods

If you want to get out of debt on your own, these two methods are two sides of the same coin for those who have multiple sources of debt.

The avalanche method involves focusing on the source of debt with the highest loan balance first. The idea is that you make minimum payments on your other debts while throwing everything else that you can at the debt with the highest balance until it’s paid off.

The snowball method operates the same way but in reverse. You put your extra funds towards the debt with the lowest balance first. Some people prefer this method because you get the success of completely paying off some of your debt faster.

You can also decide which debt to focus on first by using the interest rate instead of the loan’s balance for each of these methods.

Credit counseling agency

Credit counseling agencies are usually non-profit organizations that can help you manage your finances. They’ll review your spending and help you come up with a plan to get out of debt. If your situation is dire enough, they may even be able to negotiate with your creditors on your behalf.


Nobody wants to go bankrupt, but sometimes it’s the best option remaining on the table. Unlike with the game of Monopoly, going bankrupt isn’t the end of the story. 

Your credit will take a massive hit and the bankruptcy will stay on your credit report for up to ten years. But you can rebuild your credit over time and your existing debts will be resolved.

Final Thoughts on Debt Consolidation vs. Debt Settlement

The right choice for you will depend on your unique set of financial circumstances. You may very well end up saving money with debt settlement. However, the negative impact on your credit score will last for years, and there’s no guarantee all your creditors will come to terms.

If you can afford to repay a debt consolidation loan, you can streamline your monthly payments and even potentially raise your credit score over time.

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Checking your options won’t affect your credit score.

The Short Version

  • Debt consolidation and debt settlement are fundamentally different. Debt consolidation involves taking out a loan, while debt settlement includes negotiating with creditors
  • Pros of debt consolidation include simplifying your finances, fast approval and potentially improving your credit
  • Pros of debt settlement include potentially owing less money to your creditors and getting out of debt faster
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