Debt Settlement vs. Debt Consolidation: What’s the Difference?

Debt settlement and debt consolidation are two common ways to wipe out debts, such as credit cards and personal loans. However, they work in very different ways.

The primary difference: Debt settlement lets you clear away debt without paying back the full amount you owe, while debt consolidation requires you to pay back all of the money you owe with interest. Both types of debt relief have pros and cons.

One Low Monthly Payment vs. Paying Off Multiple Creditors 

When you sign up for a debt settlement program, a for-profit debt settlement company typically works with credit card issuers and other creditors to “settle” your debt for less than what you owe. This involves adding your money to a special savings account, which the debt settlement company then uses to pay off each creditor.

Debt consolidation, however, involves taking out one loan to pay off several debts. This leaves you with one monthly payment that should be easier to manage and perhaps come with a lower interest rate than all of the individual payments.

READ MORE: Is debt settlement the fastest way to get out of debt?

Key Differences Between Debt Settlement and Consolidation

Several key differences stand out between debt settlement and debt consolidation.

When you sign up for a debt settlement program, you:

  • Normally work with a for-profit company to negotiate debt payments to your creditors, such as credit card issuers.
  • Typically pay off your debts with money deposited into a special savings account set up with the debt settlement company.
  • Generally, stop making payments toward the debts while the debt settlement company is negotiating with your creditors.
  • May be required to pay taxes on the difference between what you originally owed and what you ended up paying to settle your debts.

When you consolidate debt, you:

  • Take out one loan to pay off several debts at one time.
  • Pay off the debts once you get money from the loan.
  • Do not negotiate with your creditors to decrease the amount you owe.
  • May have to qualify for a debt consolidation loan or a balance transfer credit card. Your credit history likely will affect your odds of being approved for a loan or balance transfer card.
  • Still pay interest on the debt.

READ MORE: Is it better to settle a debt or pay in full?

The Basics of Debt Settlement 

So, how does debt settlement work? Here are some of the basics:

  • A borrower works with a debt settlement program, typically operated by a for-profit company, to settle unsecured debts (those not backed up by collateral), such as credit cards and personal loans. Normally, the borrower stops making payments on the debts being settled, and the company handles all communication with the creditors about reducing the amounts you owe.
  • The borrower pays money into a special savings account each month while the debt settlement company works with creditors or debt collection agencies to agree on the dollar amounts that ultimately will be repaid.
  • Once the debt settlement company and the creditors agree on settlement amount, the company begins sending payments from the savings account to the creditors.
  • Overall, the debt settlement process generally lasts 24 to 48 months.

Drawbacks of debt settlement include:

  • Because debt settlement companies usually encourage you to stop making direct payments to creditors, this negative information likely will show up on your credit reports and hurt your credit score. At the same time, creditors may charge penalties and fees if you quit making regular payments to them.
  • Debt collectors still may bug you about paying off your debts. And you may even be sued for failing to make timely payments.
  • The debt settlement company might not be able to reach payoff agreements with all of your creditors.
  • You may be overwhelmed by making regular deposits into your debt settlement account and end up dropping out of the debt settlement program before your debts are paid off.
  • Any monetary savings you gain from a debt settlement program could be taxed by the IRS.

READ MORE: Pros and cons of debt settlement

While debt settlement sounds great, the National Consumer Law Center warns that debt settlement companies “often cheat consumers with high fees and rarely deliver on their promises.”

Fees charged by debt settlement companies often add up to 15% to 25% of the amount of debt that is enrolled. So, if the total enrolled debt amount is $20,000, the company’s fee could range from $3,000 to $5,000.

READ MORE: Here are the best debt settlement companies

The Basics of Debt Consolidation  

So, how does debt consolidation work? Here are some of the basics of debt consolidation.

  • Debt consolidation works by applying for a new loan or balance transfer credit card with the sole purpose of using the borrowed money to pay off several debts in one lump sum. This is an attractive debt relief option if you have great credit.
  • Once you take out a debt consolidation loan, you can use the money to pay off various creditors and consolidate those debts into one easier-to-track monthly payment. 
  • You may be able to score a lower interest rate for a debt consolidation loan than the combined interest rate for the debts you’re paying off. Over the long haul, this can decrease the amount of interest you pay.

Options for debt consolidation include:

  • Personal loan: You can apply for a personal loan from traditional banks, credit unions and online lenders. As of December 2022, interest rates for personal loans ranged from about 5% to 36%.
  • Balance transfer credit card: A balance transfer card enables you to pay off several debts (usually credit cards) at an interest rate that’s typically lower than overall rate for your current debts. These cards typically offer an introductory 0% APR interest rate for 12 to 21 months. After that, the card’s APR (annual percentage rate) goes up to its regular rate.
  • Home equity loan: This type of loan lets you borrow money based on how much home equity you’ve built up.
  • Cash-out refinance mortgage: This kind of loan also is tied to the amount of home equity you’ve got. When you obtain a cash-out refi loan, you’re replacing with your existing mortgage with a new, larger mortgage. The difference between the old and new mortgage gives you a lump sum of cash to consolidate debt or use for other purposes. 
  • 401(k) or retirement plan loan: You may be able to borrow money from your workplace retirement plan and put it toward debt consolidation.

Drawbacks of debt consolidation include:

  • If you have less-than-great credit, you may not qualify for a debt consolidation loan.
  • While debt consolidation can be an excellent tool for debt relief, it may not solve the issues that led you to pile up a lot of debt.
  • You might jeopardize ownership of your house if you take out a home equity loan or cash-out refi loan to consolidate debt and fall behind on loan payments.
  • If you use a loan for a 401(k) or another retirement plan, you’ll miss out on potential investment earnings on the money you borrow.

READ MORE: Best debt consolidation loans and companies

How Do I Choose?

You should ask yourself several questions before choosing debt settlement or debt consolidation to determine which works best for your situation.

  1. How much is my total debt? Adding up your total debt will help determine whether it makes sense to pay off part of your debt through debt settlement or pay off the full amount of your debt through debt consolidation.
  2. Can I get approved for a debt consolidation loan or a balance transfer credit card? If your credit is great, you might qualify for a loan or balance transfer card. But if your credit isn’t solid, you might need to opt for debt settlement. Be sure to check your credit reports and credit scores before applying for a loan or credit card.
  3. Are you financially stable enough to keep up with debt payments? With debt consolidation, you’ll pay the entire amount of the debt owed on a new loan, although at a lower interest rate and in one monthly payment. Late payments on new debt likely will lead to late fees and could leave you in an even worse position. With debt settlement, the payments could stretch out over several years, perhaps putting you in a long-term financial bind.
  4. What shape is your credit in? Typically, a lender checks your credit when you apply for a debt consolidation loan. A less-than-great credit score could mean you’ll pay a hefty interest rate or be disqualified as a borrower.

If you’re unsure which option is right for you, a nonprofit credit counseling agency that’s a member of the National Foundation for Credit Counseling (NFCC) can help you evaluate your financial situation.

READ MORE: Is it better to settle a debt or pay in full?

To learn more about credit counseling, check out this video:

Doing It Yourself

Debt settlement and debt consolidation can both be done in a DIY fashion.

Debt consolidation can be done on your own by simply applying for the type of loan or balance transfer card you want and paying off your debts after the loan is approved. Once your debts are consolidated, devise a financial plan to make your monthly payments to avoid future financial trouble.

DIY debt settlement is an option if you have the patience to deal with creditors without help from professionals. You’ll need to establish a budget and then negotiate with each creditor on a repayment plan.

READ MORE: Debt settlement qualifications

What Comes Next

The changes you see will depend on the method you choose.

Debt Settlement

At the outset, enrollment in a debt settlement program can cause your credit to suffer. That’s especially true because debt settlement companies normally encourage you to stop making payments on debts while a settlement is being negotiated and while money is accumulating in your debt settlement account.

However, as your creditors are being paid off, you should see your credit and your financial situation improve over the long run. And once all the debt payments are made, you can get creditors off your back and begin rebuilding your credit.

READ MORE: Debt settlement’s impact on your credit score

Debt Consolidation

As you pay off your debt consolidation loan or balance transfer card, you should see your credit scores go up if you always make on-time payments. But this will happen only if you continue to use credit responsibly.

READ MORE: Best debt consolidation loans

Other Options

Debt settlement and debt consolidation aren’t your only options for seeking debt relief. Two alternatives are enrolling in a debt management plan or filing for bankruptcy.

Debt Management Plan

A nonprofit credit counseling agency can come up with a debt management plan to help you dig out of debt. If you’re approved for a debt management plan, the agency works with your creditors to lower the interest rates on your debts. You make a single payment each month to the agency, which then distributes money to each of your creditors. This process makes it easier and less costly to pay off your debts over, say, a three- to five-year period.

READ MORE: Debt settlement vs. Debt Management Plans


A debt management plan can help you avoid filing for bankruptcy, which should be viewed as a last-resort option for debt relief. You’ve typically got two options for submitting a bankruptcy case to a federal court: Chapter 7 and Chapter 13. Chapter 7 wipes out your debts, while Chapter 13 puts you on a three- to five-year repayment plan. A bankruptcy can stay on your credit report for seven years (Chapter 13) or ten years (Chapter 7), meaning you’ll cope with long-term damage to your credit. 

READ MORE: Which type of bankruptcy is right for you?

The Bottom Line 

Before deciding on whether to pursue debt settlement or debt consolidation, take a close look at your current financial situation and give careful thought to the long-term consequences of each option. If you approach them responsibly, either debt settlement or debt consolidation can lead to a brighter financial future.


Are There Debt Consolidation Loans for Bad Credit?

Yes, lenders (particularly online lenders) do offer debt consolidation loans to borrowers with bad credit. Be aware that if you do have bad credit, you’ll likely be charged a hefty interest rate for a debt consolidation loan.

Do Debt Consolidation Loans Hurt Your Credit?

While debt consolidation can streamline your monthly debt payments, it can hurt your credit. You’ll probably see a temporary dip in your credit score when you apply for a debt consolidation loan. Your credit score could suffer even more if you fail to make timely payments on the loan.

Can I Use My Credit Cards After I Consolidate My Debts?

Sometimes you may be required to close a credit card account as part of debt consolidation. But in other cases, such as if you took out a HELOC, you should be able to use your credit cards following debt consolidation. The answer depends partly on what type of debt consolidation method you choose.

What Happens If I Can’t Pay Off My Debt Settlement or Debt Consolidation Loan?

Failing to pay off a debt settlement or consolidation loan can seriously damage your credit. In addition, you could be hit with a lawsuit from a creditor or debt collector seeking at least some of the money you owe.

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