Debt Settlement vs Debt Consolidation: Which Is Right for You?

Saying debt can be a major stressor is a serious understatement. And if you're struggling and you're looking for relief that goes beyond just budgeting or figuring out a new repayment strategy, you want to make sure you know what your different options are. You might've heard about debt consolidation and debt settlement. Now, these sound pretty similar and sometimes you'll see companies use them kind of interchangeably, but these are really different processes that are geared toward people in really different situations. I've been on the lending team at NerdWallet for the past five years, and my colleagues and I spend all our time pretty much, well, nerding out on this stuff so that we can help you make the right money moves. So today, let's talk about the differences between debt consolidation and debt settlement. Before we get too far, let's stop and define our terms. So debt consolidation takes multiple debts, say from different credit cards, and it rolls them all into one single payment. So that can help you get organized because instead of dealing with multiple monthly payment amounts, multiple interest rates, multiple due dates, you've just got one of everything. Even better, if you can get a lower interest rate, you could potentially pay less on your entire debt. To do it, you can get a debt consolidation loan or you can move your existing debts to a balanced transfer credit card. On the other hand, debt settlement is a process, and it's a process where usually with outside help, your debt will get negotiated down to a lower amount than what you currently owe. Debt settlement can be used for different kinds of debts that aren't collateralized. So things like medical debt, personal loans, credit cards, anything where you didn't put something up in order to get the loan. That all sounds pretty good, but it's important to know that debt settlement can be both costly and risky. In order to do it, you'll usually work with a debt settlement company, and that is not free. They will charge you between 15% and 25% of the amount that you owe. It can take years to settle debt, and there's no guarantee that it's actually gonna work. Now, unsurprisingly, your credit score is going to come into play with either one. With debt consolidation, if you're looking to open a balanced transfer credit card, obviously you want your credit score to be high enough that you're able to qualify. Ideally, you're looking for a balanced transfer card that has a 0% introductory APR, and to get that, you are going to need a strong score, usually 690 or higher. With a debt consolidation loan, same as with pretty much any type of loan, the higher your credit score, the lower the interest rate that you're likely to be offered. With debt settlement, going in, you need to recognize that your credit score is going to take some serious damage, and that's basically because of the way that debt settlement works. So debt settlement companies will generally have you stop making payments towards your debt because they're trying to convince your debtors that you are simply not going to pay them. Instead, you are going to put that money into an escrow account, and the settlement company will use that to eventually, hopefully, make the settlement. But while this is going on, you are missing payments, and that is going on your credit reports. And those missed payments can linger for as long as seven years. Adding insult to injury, settling the debt can also hurt your credit score. Your overall debt load and your ability to manage it right now is also going to play into whether debt consolidation or debt settlement would make sense for you. If your monthly debt payments are less than 50% of your pre-tax monthly income, and you can commit to making payments against that debt, debt consolidation can work for you. But you also need to make sure that you can make a commitment to paying down that debt. So if you're going for a balance transfer credit card, you want to feel fairly certain that you could make at least a year's worth of payments on that debt. With a debt consolidation loan, like any personal loan, it's going to last a bit longer. So you're looking at perhaps five to seven years of repayments. On the other hand, if you feel fairly certain that you could not possibly repay what you owe, debt settlement may be an option. Again though, because it is costly and there is risk involved, you want to be sure that you've explored all other avenues first. That said, you might still decide that the possibility of lowering your debt might be worth it. You also need to consider whether either of these approaches will actually solve your problem. With debt consolidation, for example, debt consolidation doesn't get rid of any of your debt. You're not lowering it. You're simply changing the way that you're paying it back. So if you aren't open to changing some of your money habits, whether you're in debt because you're overspending or because you keep borrowing in order to stay afloat, debt consolidation isn't really going to help you get ahead. And it could actually be a further setback. I've described debt settlement as risky a bunch of times. And the biggest risk is just that it might not work. You have no way of knowing whether your creditors will actually accept the settlement. And if they don't, you are right back at square one. Even if they do, however, the process can take years. During that time, your debt is accruing interest and you also might be piling up fees with the settlement company. Overall, you could end up paying out so much that your savings is pretty much offset by the cost. If neither of these is really sounding like they fit your situation, there are other options. So if debt settlement, for example, seems like it is just not enough, you could consider a filing for bankruptcy. If you're dealing with credit card debt and you're concerned that your credit score isn't high enough to get a balance transfer credit card, you could work with a credit counselor to get on a debt repayment plan. And if even consolidation sounds like it's really more than you need, simply figuring out a DIY strategy for dealing with your debt might be enough. You can find information on all of these options and pretty much everything else we've talked about today at nerdwallet.com. I'm Kate Wood and I'm a writer on the lending team at NerdWallet. If you're interested in a debt consolidation loan, head to nerdwallet.com to check out our list of the best lenders. 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