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Which Is Better?: Debt Consolidation Vs. Debt Settlement

Miranda Crace6-Minute Read Time
UPDATED: July 11, 2024


It’s easy to fall into a financial hole, especially during the age of COVID-19, when many people are struggling with unemployment.

Thankfully, there is hope for getting back on track! If your financial debt is soaring, you can turn to debt settlement or debt consolidation to help boost your financial health and cut down on the amount you owe to creditors.

Be aware that debt consolidation and debt settlement are not the same thing. They both come with their own pros and cons lists, and they both provide different paths for paying down your debt.

Here’s a closer look at these debt-reduction strategies. Make sure to fully research debt consolidation versus debt settlement before deciding what works best for you.

What Is Debt Consolidation Vs. Debt Settlement?

The biggest difference between debt settlement and consolidation is how you pay off your debt.

How Debt Settlement Works

In debt settlement, you negotiate with your creditors to settle a large portion of your debt, offering to pay less than what you owe. The amount that is forgiven will vary depending on your lender and financial situation.

For instance, say you owe $10,000 to one of your credit card providers. You and your creditor might agree on a $7,000 payment. Once you make this payment, your creditor forgives the remaining $3,000 you owe on your card and wipes out the debt. You will have to negotiate separately with each of your creditors if you owe money to several banks, lenders or financial institutions.

How Debt Consolidation Works

The debt consolidation process works differently. In this payoff strategy, you may work with a debt consolidation lender to combine all of your debts into one single loan, with interest. You then make a payment that you can afford each month to your new lender until you pay off all that you owe.

Keep in mind that with debt consolidation, your debt might get reduced, but it isn’t forgiven. You might end up with a lower interest rate on your new loan, but your debt remains, and you still must pay it off over time with regular monthly payments.

This might make it seem as if debt settlement is the best choice. After all, a debt settlement company might forgive a good chunk of your debt. But while debt settlement is the right choice for some consumers, it’s not a good choice for everyone. In fact, working with a debt settlement company can sometimes be dangerous to the point where your finances are placed in serious jeopardy with costly fees and ambiguous timelines.

Debt Settlement: Pros And Cons

Debt settlement might sound enticing. While there are positives, especially if your debt levels are high, there are also negatives.


Here are the pros of debt settlement:

  • A portion of your debt might be forgiven. The obvious benefit of debt settlement is that your creditors might forgive a portion of your debt. If you owe a lender $14,000 and you only have to pay $8,000 to make that entire debt disappear, that can sound like a good deal.
  • You can do it on your own. You don’t have to work with an outside company to settle your debt. You can contact your credit card providers or lenders directly and make offers to them. Just be aware that none of your creditors have to accept your offers.


There can be drawbacks to debt settlement, especially if you work with debt settlement companies instead of approaching lenders and banks on your own. The Consumer Financial Protection Bureau, in fact, says that dealing with debt settlement companies can be risky.

  • Settlement companies can be expensive. Debt settlement companies charge varying fees, but you can expect to pay 15% – 20% of your total debt. If you owe $20,000, you can expect your debt settlement provider to charge you $3,000 – $4,000. The Federal Trade Commission warns that you should only work with debt settlement companies that list their fees in writing, and you should never work with one that charges its fees before it settles debt for you.
  • You could owe more in taxes. What’s more, you may end up owing a substantial amount in outstanding taxes on your settled debts. The Internal Revenue Service (IRS) regards debt that’s been forgiven as a form of income, and you will be expected to include forgiveness information on your tax return and to pay income taxes on the forgiven amount.
  • Debt settlement can plummet your credit score. Debt settlement companies often ask that you not make any payments to your creditors while they’re negotiating on your behalf, but this can cause significant damage to your credit score. When you make payments on certain monthly debts – such as your mortgage, auto loans or credit cards – more than 30 days past your due dates, these missed payments are reported to the three national credit bureaus: Experian™, Equifax® and TransUnion®. A single missed payment can send your credit score falling by 100 points or more, and these missed payments remain on your three credit reports for 7 years. If you miss several payments while your debt settlement company negotiates on your behalf, your score can take a serious dive.
  • Your creditors don’t have to accept your offer. A debt settlement company might make what it considers a fair offer to your credit card provider or lender, but there’s no guarantee that these financial institutions will agree to work with the debt settlement company or accept anything less than the full amount you owe them. Choosing to work with a debt settlement company rather than consolidating or fully paying off your debt without assistance is a gamble, and unfortunately it may not always work out in your favor.

Debt Consolidation: Pros And Cons

A debt consolidation loan might result in a smaller hit to your credit score and might come with lower upfront costs than if you were to work with a debt settlement company. However, paying off your debt with a debt consolidation loan can be a more time-consuming process.


Here are the pros of debt consolidation:

  • The process is easier. With debt consolidation, you can take several monthly payments and combine them into a single payment you’ll make each month. Instead of juggling multiple payments, you can focus on making just one that counts toward all of your owed debts. This can make your debt repayment process a lot less stressful.
  • You might end up with a lower interest rate on your debt. The goal is to get a debt consolidation loan with an interest rate that’s lower than the average rate charged on the debt you’re consolidating. If you’re able to do this, you’ll save money as you pay back your loan over time.
  • On-time payments each month can help your credit score. Every time you make an on-time payment on your debt consolidation loan, it will be reported to Experian™, Equifax® and TransUnion®. Make these payments on time each month, and your credit score will improve steadily. says that your payment history accounts for 35% of your credit score.
  • It’ll stop any annoying debt-collection calls. Once you’re paying off your debt consolidation loan each month, those calls from debt collection agencies will stop. This might seem like a small perk, but the removal of such a nuisance from your life is not insignificant, and it can further reduce the stress of your debt repayment journey.


There are some cons to debt consolidation loans, too:

  • It can take a while depending on your loan terms. Unlike with debt settlement, it can take a long time to pay off your debt using debt consolidation. That’s because creditors usually don’t forgive any of your debt in the process. You’ll have to steadily make your monthly payments – often over several years – to eliminate this debt.
  • It requires discipline. Debt consolidation won’t work if you stop making payments on your new loan. It also won’t work if you continue to run up new charges on your credit cards. That’s why it often makes sense to work with a credit counseling agency when you’re consolidating debt. A nonprofit credit counselor can help you identify why you overspend. These professionals can also give you tips on how to reduce your spending and better manage your finances as you work to pay down your debt.

Which Debt Repayment Strategy Is Better?

While the prospect of debt forgiveness can make working with a debt settlement company a tempting option, debt consolidation is ultimately the safer and more beneficial choice in the long term.

If a debt settlement company asks you to stop making payments on your loan until your account becomes delinquent and they make an offer to your creditors, you run the risk of being rejected by the creditors and incurring a hefty amount of interest charges and late fees. You’ll also drive your credit score so low that it could take years for you to rebuild it enough to be approved for future lines of credit.

With debt consolidation, your financial standing will be far more secure so long as you consistently make the monthly payments you’ve committed to.

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Options For Consolidating Your Debt

If you decide that debt consolidation is the best choice for you, prepare to do some research. There are a few different consolidation options to consider:

Debt Consolidation Loans

These loans are used as personal loans for debt consolidation. You’ll work with a lender that will provide you with a lump sum of cash, enough to pay off your existing debt. You’ll use these funds to pay off your debt, and then you’ll make monthly payments on your new loan – with interest – to repay your lender.

Debt Management Plans

A debt management plan is not a loan. Instead, you'll work with a company that negotiates with your creditors to create a payment plan with a monthly payment that you can afford. Each month, you'll make a payment to the debt management company, which uses this money to steadily pay off your creditors. It can take up to 5 years to pay off your debt under such an arrangement.

Unlike working with a debt settlement company, which typically operates as a for-profit business, debt management companies tend to be affiliated with nonprofit credit counseling agencies. This means you can move forward in paying down your debt without having to worry about whether the company you’re working with has your best financial interest in mind.

Home Equity Loans Or Lines Of Credit (HELOCs)

If you own a home, you can use a home equity loan or line of credit to tap into the equity you have in it. Equity is the difference between what you owe on your mortgage and what your home is currently worth.

For example, if your home is worth $200,000 and you owe $80,000 on your mortgage, you have $120,000 in equity. In a home equity loan, you’ll receive a lump sum from a mortgage lender. You can use this money to repay your loan in monthly installments, with interest.

A home equity line of credit works more like a credit card, with your credit limit based on the amount of equity in your residence. You only pay back what you borrow. Be careful with these financial tools; if you don’t make your payments on time, your lender could take ownership of your home through the foreclosure process.

Credit Card Balance Transfers

If you are struggling with credit card debt, you can turn to balance transfers for financial relief. In a balance transfer, you move the money you owe on one credit card to a new credit card that you open. Many credit cards offer 0% interest on balance transfers for 6 – 12 months.

This means you’ll have this number of months to pay off your transferred debt without having to worry about paying interest. The drawback? If you don’t pay off your transferred debt before the introductory 0% offer ends, the new card will charge its standard interest rate on the debt left over.

Final Thoughts

While debt settlement and debt consolidation both have perks that can appeal to borrowers in need, consolidating your debt tends to offer less risk and provide better opportunity for repayment success over the long term. However, neither of these payment strategies is right for everyone, and they’re not your only debt-reduction options.

Look closely at your finances and spending habits before choosing one method. Once you commit to reducing your debt, make sure to keep in contact with lenders on repayment strategies and stop racking up any new credit card charges. Not changing your spending habits will doom any debt consolidation or settlement efforts.

If you’re interested in pursuing debt consolidation, Rocket LoansSM can help! Prequalify for a personal loan that can help you consolidate your debt today!

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Miranda Crace

Miranda Crace is a Senior Section Editor for the Rocket Companies, bringing a wealth of knowledge about mortgages, personal finance, real estate, and personal loans for over 10 years.