JUMP TO Section Chevron icon It indicates an expandable section or menu, or sometimes previous / next navigation options.- Introduction to debt relief options
- What does debt consolidation mean?
- What does debt settlement mean?
- Key differences between debt consolidation and debt settlement
- FAQ
Affiliate links for the products on this page are from partners that compensate us and terms apply to offers listed (see our advertiser disclosure with our list of partners for more details). However, our opinions are our own. See how we rate products and services to help you make smart decisions with your money.
- Debt consolidation moves debt to another loan, while debt settlements cut the debt amount.
- While debt settlements can severely hurt your credit, debt consolidation may actually raise your credit score.
- Debt settlements are for dire situations and are your last resort before bankruptcy.
If you feel like your debt is holding you back, you're not alone. The average American debt has steadily increased since 2021.
Fortunately, there are several options for debt relief, two of which are debt consolidation and debt settlement. Understanding how each program works and its risk is essential to deciding which is appropriate for your situation.
Introduction to debt relief options
Debt consolidation combines multiple debts into a single monthly payment via a consolidation loan or a balance transfer credit card. Meanwhile, a debt settlement is an agreement you reach with your creditors to reduce the total amount of debt you owe.
| Debt consolidation | Debt settlement |
Aims to consolidate multiple high-interest debts into one debt with a lower interest rate | Aims to lower total debt amount |
Potential to increase your credit score with a lower utilization ratio | Can harm your credit score |
No direct impact on taxes | May need to pay taxes on the forgiven debt |
Must meet credit score requirements to apply for a new line of credit | No minimum credit score is required to settle your debt |
3% to 5% of the amount transferred for balance transfer cards | Expect to pay 15% to 25% of the total amount of debt |
Simple to do on your own | Generally requires the help of a debt settlement company |
What does debt consolidation mean?
Debt consolidation may be right for you if you have various high-interest debts, and it's relatively simple to do on your own. Debt consolidation reduces the number of accounts you owe. This means transferring all your outstanding debt to a single line of credit like a personal loan, balance transfer card, or home equity loan.
How a debt consolidation program works
One of the advantages of a debt consolidation program is you pay off all your bills, so you no longer have to answer to multiple creditors. You'll also be paying one bill each month instead of various accounts. Additionally, the best debt consolidation loans tend to have lower interest rates than credit cards, which means you save money with this relief program.
Another way to save on interest rates is by applying for a balance transfer card with a 0% introductory APR. In addition to paying off your debts interest-free, your balance transfer fees may be waived. However, you should pay off your card before the promotion ends (usually within one to two years). Otherwise, you'll have to start paying interest rates on your remaining balance, with rates similar to a credit card.
Before applying for personal loans, keep in mind that lenders may require a decent credit score to qualify for a debt consolidation loan with favorable rates. Additionally, some debt consolidation loans require collateral, says Natalia Brown, Chief Client Operations Officer at National Debt Relief. Brown also explains that additional costs, such as prepayment and origination fees, can increase the cost of your loan.
What does debt settlement mean?
Debt settlement reduces the amount you owe. This debt relief program requires negotiating with your creditors to a settled amount for a single lump sum payment upfront.
Alternatively, you can work with a debt settlement company that negotiates on your behalf, increasing your odds of your credits forgiving a portion of your debt. These companies require that you stop paying your creditors and deposit that money in a savings account instead. Once the debt settlement company determines you have enough money in that account, it will go to your creditors and begin negotiations.
Companies use repayment as leverage to persuade creditors to a settled amount. After all, debtors and creditors would collect some of your payment instead of none. You can find our list of the best debt settlement companies here.
How a debt settlement program works
While this type of debt forgiveness program can be enticing as you no longer have to pay a large portion of your debt back, it's usually not the best option. You should only consider debt settlement for extreme cases, often before filing for bankruptcy.
A debt settlement program can spell major repercussions on credit scores since you're withholding payments from your creditors, which can put you in serious delinquency. When you settle debt, that negative mark will stay on your credit report for up to seven years. As the debt ages, its effect on your credit score will abate.
Also, if you work with a debt settlement agency, you may have to pay a hefty fee for the service, usually 15% to 25% of the amount of your enrolled debt. Additionally, the IRS considers your forgiven debt taxable income. So, you still have to pay taxes on the settled amount.
Key differences between debt consolidation and debt settlement
How to choose between debt consolidation and debt settlement
With debt consolidation, you must pay your entire debt, though your terms will be better. Meanwhile, debt settlement means you won't have to repay a portion of your debt.
When debt consolidation makes sense
With debt consolidation, you must pay your entire debt. However, this program provides debt relief by reducing your interest rates. You might choose debt consolidation if:
- You have multiple high-interest debts: By consolidating your debt, you can roll your debt payments into a loan with a better interest rate. If your debt is primarily comprised of credit card debt, you should apply for a balance transfer credit card with a 0% APR. Ideally, you'll pay off most, if not all, of your debts within that introductory period.
- You'd like to make your debts manageable: This debt relief program streamlines your debt payments into one payment per month instead of several monthly payments.
- You have a decent credit score: If you have a good credit score, you have a better shot at getting the best rates. "Debt consolidation may not be the best option if an individual only has a small amount of debt or if an individual has a poor credit history because they may not qualify for a low-interest consolidation loan," says Brown.
When debt settlement makes sense
Debt settlement should be used as the last resort before you declare bankruptcy. It may be worth it if you're out of other options. You might choose debt settlement if:
- You're settling debt on a single account: Settling your debt on a single account may hurt your credit score, but not as much as settling debt on multiple accounts.
- You have more than $10,000 in debt: Most debt settlement companies require you to have at least $10,000 in debt to access their services.
- You're on the verge of bankruptcy: Debt settlement can be your lifeline if bankruptcy is a likelihood for you. "Consumers should consider a debt settlement if they're facing bankruptcy, if their payments are severely past due, have been charged off by your creditor, or are facing a lawsuit," says Bruce McClary, senior vice president of the National Foundation for Credit Counseling. While debt settlements can hurt your credit score, that decrease will still be smaller than the effect a bankruptcy has on your credit.
"If you are in the earlier stages of delinquency with your credit cards and unsecured debt, nonprofit credit counseling may be a more suitable choice before turning to debt settlement," says McClary. Many nonprofit credit counselors offer free consultations to help you discover debt relief options for your situation.
Frequently Asked Questions About Debt Consolidation and Debt Settlement
What types of debts are eligible for consolidation and settlement? Chevron icon It indicates an expandable section or menu, or sometimes previous / next navigation options.Most types of unsecured debt can be consolidated or settled, but eligibility varies.
How do I choose a debt settlement company? Chevron icon It indicates an expandable section or menu, or sometimes previous / next navigation options.To choose a debt settlement company, avoid companies that reach out via robocall or guarantee results. It's also illegal for a debt settlement company to charge up-front fees.
Which option is better for my credit score? Chevron icon It indicates an expandable section or menu, or sometimes previous / next navigation options.Debt consolidation is typically better for your credit score than debt settlement because it has a lesser impact on your score.
How long does debt consolidation take compared to debt settlement? Chevron icon It indicates an expandable section or menu, or sometimes previous / next navigation options.Debt consolidation can take several years, whereas debt settlement may be completed faster but with greater potential impact on your credit score.
Jennifer Streaks Senior Personal Finance Reporter and Spokesperson Jennifer Streaks is a personal finance expert who writes about credit for Business Insider. She has covered financial topics for over a decade, writing about her own experiences and sharing her expertise to give consumers actionable financial advice.Along with exploring credit scores, credit reports, and how to build credit, Jennifer analyzes how current economic trends impact everyday people and offers her expert advice on budgeting, saving, and growing wealth in today’s economy. She regularly appears as an on-air financial commentator on programs like Good Morning America, CBS, and MSNBC.ExperienceBefore joining Business Insider, Jennifer was a financial contributor for CNBC and covered personal finance, entrepreneurship, tech, and the economy for Forbes. Her work has appeared in TheGrio, Black Enterprise, and USA Today. Jennifer is also the author of "Thrive! ... Affordably: Your Month-to-Month Guide to Living Your Best Life Without Breaking the Bank." The book offers advice, tips, and financial management lessons geared toward helping the reader highlight strengths, identify missteps, and take control of their finances.Jennifer’s most important financial advice to her friends is to always have an emergency fund.ExpertiseJennifer’s expertise includes:- Credit scores
- Credit history
- Credit reports
- Budgeting
- Saving
- Housing
- Retirement
- The economy
- Financial trends
Alani Asis Alani Asis is a personal finance expert with experience covering insurance, retirement, and credit at both Business Insider and LendingTree. Her work has been published in AARP, CNN Underscored, Forbes, Fortune, PolicyGenius, and U.S. News & World Report.ExperienceAlani is a former insurance fellow on the Personal Finance Insider team. She’s reviewed life insurance and pet insurance companies and has written numerous explainers on travel insurance, credit, debt, and home insurance.She is passionate about demystifying the complexities of insurance and other personal finance topics so that readers have the information they need to make the best money decisions.ExpertiseAlani’s areas of personal finance expertise include:- Car insurance
- Life insurance
- Home insurance
- Travel insurance
- Pet insurance
- Credit
- Credit cards
- Retirement planning
Chime® Checking Account Set up Direct Deposit and get your paycheck up to 2 days before your coworkers.** No overdraft fees. No monthly fees. A tooltip Chime is a financial technology company, not a bank. Banking services provided by The Bancorp Bank, N.A. or Stride Bank, N.A., Members FDIC. **Early access to direct deposit funds depends on the timing of the submission of the payment file from the payer. We generally make these funds available on the day the payment file is received, which may be up to 2 days earlier than the scheduled payment date. Start BankingReference
ncG1vNJzZmivp6x7o8HSoqWeq6Oeu7S1w56pZ5ufonyxsdGspqeZnGKzqrrAp5qeZ5OnsqW102aqnKeimnylscGtZJynnqi8rbXDmquip55iw7R5w56ZrWWjmsG1uMSmnKes