Debt Settlement vs Debt Consolidation
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Interest rates have been rising steadily throughout 2022 as the Federal Reserve continues to try to bring down historical inflation rates. This means carrying a balance on a credit card or loan with a variable rate has become more expensive if you hold debt.
If you’re struggling to pay down your debt — whether from credit cards, medical expenses, loans, or any other form of debt — there are ways to make monthly payments more manageable and start making a dent in the total amount you owe.
While there are many methods for paying down debt, creating a repayment plan and considering debt settlement are two popular options. We’ll walk you through these debt relief options so that you can find the right path forward to a debt-free future.
In this article
Debt settlement vs. debt consolidation: What’s the difference?
At first glance, both debt settlement and debt consolidation programs may seem to be the same — they both aim to help you reduce or eliminate your amount of debt. However, there are key differences.
A debt settlement agreement is a legal accord you reach with your debtors (like credit card companies, lenders, mortgage companies, or banks) to pay a certain amount to wipe away your debt. In some cases, like bankruptcy, you may be able to eliminate all of your debt. But there are some catches. And keep in mind that forgiven debt is a rarity.
Debt consolidation, however, helps you combine all of your owed balances into one payment — sometimes with a lower interest rate to help you save more money on your monthly payments. It doesn’t lessen the amount you owe but can make repayments more manageable.
So which method is right for you? In most cases, debt consolidation will make the most sense for most people. However, there are times to consider debt settlement. I’ll walk you through some common types of each so you can determine which method sounds right for your financial situation.
Types of debt settlement
There are a few different types of debt settlement. In some cases, you can negotiate a debt settlement on your own, while more extreme forms of debt settlement — specifically bankruptcy — require a lawyer.
Negotiating debt on your own
If you have a past-due balance, you can sometimes successfully negotiate your existing debt down to a more manageable balance or monthly payment. This strategy can be used with many types of debt but is often most effective with past-due credit cards or collections accounts.
To start, figure out what you can afford to pay. For instance, if you have a $1,200 balance in collections and you can pay $800, you may be able to negotiate with the collection agency to lower your balance to the amount you’re able to pay. In this case, the remaining balance would be written off, and your account would be closed.
It’s not impossible to negotiate your debt, but it’s also not a strategy you should expect to solve your financial problems. Creditors are under no obligation to lower your balance, and collections agencies could sue you for the amount owed. That said, it’s worth trying if you can pay a good chunk — but not all — of your debt.
Make a commitment to get out of debt with a dedicated team that will support you every step of the way, providing you with the necessary resources and assistance to achieve financial freedom. You’ll get the help you need without paying any fees for our services until your debts are reduced and you save money.
See if you qualify for credit card relief.
Debt settlement through a lawyer or debt settlement company
If you’re struggling to pay your bills and other debt balances, working with a lawyer or credit counseling agency may make sense to lower your account balances. In this case, the lawyer will work with you to reach out to creditors with a proposed settlement agreement.
This can demonstrate your financial hardship and may show creditors they are unlikely to receive full payments for you. Your debt may be lowered in these instances, but it’s rarely erased entirely. Usually, you’ll receive a settlement offer to agree to.
Be sure to look for a nonprofit credit counseling agency, and don’t turn to companies asking for upfront payments, as many of these are scams. Do your research and look for reviews and ratings on the Better Business Bureau before committing to an option.
Bankruptcy
You can consider filing bankruptcy to lower or wipe out your debt as a last resort. But bankruptcy is an extreme action and one you shouldn’t take lightly. That said, there are two different types of bankruptcy — Chapter 7 bankruptcy and Chapter 13 bankruptcy.
Chapter 7 bankruptcy can wipe out your unsecured debts (credit card debts, medical debt, personal loans, etc.). First, your valuable assets will be liquidated to pay off your debtors — this may mean you’ll lose your home or car (in some cases) and other valuables. There are exceptions here, but it’s best to ask your lawyer upfront about the expectations.
Chapter 13 bankruptcy, on the other hand, is more of a debt reorganization. It often requires you to agree to a minimum lower monthly payment for a set amount of time, after which your debt will be cleared. Some debts might be discharged, but it’s more of a debt consolidation tactic that can make repaying debt more affordable. You’re likely to be able to keep your home with this type of bankruptcy.
Both types of bankruptcy will negatively affect your credit report, making it hard to apply for new credit accounts immediately. However, Chapter 13 bankruptcy will fall off after seven years, while Chapter 7 remains on your report for 10.
Types of debt consolidation
Now that you understand how debt settlement works let’s look at different types of debt consolidation methods you can use to restructure your debt.
Debt consolidation loan
Arguably the most popular debt consolidation method, this technique allows you to take out a personal loan that you then use to pay off all your existing debts. You’ll then make monthly payments on your new loan instead of various credit accounts.
This method is often the best solution for most people with debt because you can find various personal loan types and amounts you can use to consolidate your debt. And personal debt consolidation loans typically have lower APRs (annual percentage rates) or interest rates and fees than credit cards.
So, if you have five credit cards with different balances, you can combine the total debt you owe onto one loan with a lower APR and pick your loan term. A longer loan typically lowers your monthly payments — though you’ll pay more in interest than you would with a shorter-term loan.
It’s also possible to find debt consolidation loans and options with less-than-perfect credit, making this a good strategy if you need to take charge of your debt. Just watch out for origination fees, which charge you a percentage of the loan amount you borrow. While you can’t always avoid them (unless you have good credit), you can compare the lowest fee options.
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Balance transfer credit card
In some cases, it may make sense to transfer your credit card balances to a balance transfer card. This card type allows you to move other card balances onto it — typically for a fee — at a low or even 0% introductory APR. Most balance transfer cards offer 0% APR for 12-24 months, giving you a year or two to repay your balance before interest kicks in.
This debt consolidation strategy is best for those with good credit who can stick to a diligent repayment schedule. During your introductory balance transfer period, you’ll need to make regular monthly payments (the minimum, at least, but paying more can help you repay your balance in time). You also shouldn’t use this card for new purchases while repaying balances, as it causes purchase APR to kick in — but beyond that, think of it as a debt repayment strategy and not a card you should use for goods and services.
You’ll want to make sure you can repay your balance in full before the intro APR period ends. If you can’t, it may be better only to transfer the balance you can afford to pay off so that you avoid getting hit with higher-than-average APRs at the end of your intro period.
Compare this option with a personal loan to avoid high interest rates and to decide if the balance transfer fees (usually 3% to 5%) are worth it.
Create a debt management plan
If applying for new credit isn’t going to help you reach your debt repayment goals, coming up with a debt management plan might. To get started, you’ll want to look at all of your credit cards and current balances. Figure out which cards have the highest and lowest APRs. After fulfilling minimum monthly payments, decide how much extra you can put towards your debts. In some cases, you may need to cut back on other expenses to find wiggle room in your budget.
From there, you can tackle your debt in a few different ways. You can pay the minimum and then equally apply the extra money you have across each card every month. Or you could try the debt snowball method, in which you pay the minimum on all your cards (and any other debts) and then add extra payments to the card with the smallest balance. Once the smallest balance card is paid off, you can move on to the next. This strategy lets you see easy credit wins and victories early on, motivating you to continue your debt journey.
Another popular method is the debt avalanche method, in which you pay off the card with the highest APR first (while still making minimum payments on all debts). This can save you more money in interest, decreasing the amount you’ll pay overall.
The method you choose is entirely up to you — just be sure to celebrate as your balances decrease and keep the momentum going. And as always, pay your minimum balances on all your debt accounts to avoid late fees and legal issues.
Other debt repayment strategies
You also have other options to attack credit cards, personal loans, and medical debt — but they should be explored with caution. If you own a home, for instance, taking out a home equity loan or HELOC (home equity line of credit) can help you tap into your home’s equity.
A home equity loan is a lump-sum payment of the money you borrow, similar to a personal loan, that you begin repaying immediately. A HELOC is a line of credit, meaning you draw on it for a certain period of time (usually 10 years), then begin repaying once the draw period ends.
But you should only look to borrow against your home equity when you know you can repay the loan on time and in full. That’s because a home equity loan or line of credit borrows against your house. You may lose your house if you cannot keep up with monthly payments.
That said, if you are certain you can maintain the monthly payments, you may secure a lower rate than you would with a personal loan with a home equity loan. And, if you opt for a HELOC, you only repay the amount you use.
Another strategy you may consider is taking out a loan against your 401(k). If you have an employer-sponsored 401(k) plan, you can take out a loan against this plan. You don’t need to undergo a credit check to access this money, which may make it more appealing if you’re worried about your credit score or credit rating.
However, a 401(k) loan is not a great idea because it can hurt your retirement fund. Investing early is the best way to grow your money for retirement, and pulling from this fund can greatly impact how much you retire with.
Many workplaces also have rules around how much you can borrow and strict repayment guidelines, so use this option only as a last resort.
Make a commitment to get out of debt with a dedicated team that will support you every step of the way, providing you with the necessary resources and assistance to achieve financial freedom. You’ll get the help you need without paying any fees for our services until your debts are reduced and you save money.
See if you qualify for credit card relief.
The bottom line
Understanding your debt, how much you owe, and how much you can afford to pay each month can help you decide which debt repayment option will work best for you. While debt repayment plans will likely make sense for most, in some cases, declaring bankruptcy and attempting debt settlement may be more beneficial to lower your overall debt burden.
There’s no one-size-fits-all debt repayment solution. Individual circumstances vary, so the right method for you will probably look different than someone else's. If you need help deciding which method is right, reach out to a qualified non-profit credit counselor to explore your debt relief options or to enroll in a debt management program.
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Writer
Courtney Johnston is a freelance writer, specializing in finance, travel, and health. She has written for The Chicago Tribune, Benzinga, BestReviews, Mashvisor, Fundera, MoneyGeek, and The Culture Trip. She also teaches writing instruction at the University of Indianapolis. Courtney currently resides in Indianapolis.
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