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Debt Consolidation vs. Debt Settlement: A Comparison

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In a Nutshell

Both debt consolidation and debt settlement can help relieve the pressures of overwhelming debt, but they have different functions. Debt settlement reduces total debt by allowing a debtor to pay off a debt account for less than the total balance. Debt consolidation, on the other hand, reduces the number of lenders but doesn’t reduce the total amount of debt. Each option has its pros and cons. If you’re considering using either of them, you’ll want to know what those pros and cons are.

Written by Natasha Wiebusch, J.D.
Updated July 28, 2023

According to CNBC, the average American has $90,460 of debt. Every year, millions of these Americans research debt relief solutions to help them out. Two common solutions that many Americans take advantage of are debt consolidation and debt settlement. 

Both debt consolidation and debt settlement can help relieve the pressures of overwhelming debt, but they have different functions. Debt settlement reduces total debt by allowing a debtor to pay off a debt account for less than the total balance. Debt consolidation, on the other hand, reduces the number of lenders but doesn’t reduce the total amount of debt. 

Each option has its pros and cons. If you’re considering using either of them, you’ll want to know what those pros and cons are.

What Is Debt Consolidation?

Debt consolidation is a debt relief method that involves combining several debts, or multiple lines of credit, into a single debt account. Once the debts are consolidated, you’ll only make one payment on the consolidated debt.

If you’re considering debt consolidation, there are a few things to know before moving forward: 

  • It won’t erase the debt. Debt consolidation doesn’t erase your debt. Although the single payment will be more convenient and help you avoid making late payments, you’ll still have the same amount of debt to pay off. 

  • Your debt might take longer to pay off. If you lower your monthly payments through debt consolidation, it will likely take longer to pay the total debt off. This is because your lender will have to extend the loan period to decrease the payment amount. 

  • A lower interest rate isn’t a guarantee. A lower interest rate is desirable, but it’s not always guaranteed. Before consolidating, understand what your average interest rate is and compare how much interest you’ll pay through consolidation with how much you’ll pay if you keep your debts separate. Also, if your credit rating is low, you’re less likely to get a good interest rate. 

  • Consolidation involves fees. Depending on how you consolidate your debt, you will either need to pay administration fees to a credit counseling agency or an origination fee to your lender. 

How To Consolidate Debt

There are two approaches to debt consolidation. You can either set up a debt management program — also called a debt management plan or debt consolidation program — or you can apply for a debt consolidation loan through a lender. 

Debt Management Programs (DMPs)

DMPs are usually organized through nonprofit credit counseling agencies. These agencies will negotiate new schedules and new terms on your behalf. Then, as the debtor, you’ll make one monthly payment to the credit counseling agency. Through a DMP, you can only consolidate unsecured debt, like credit cards, medical bills, or payday loans. Secured debts, like mortgages and car loans, generally can’t be bundled into a DMP.

Debt Consolidation Loans

Another way to consolidate debt is through a debt consolidation loan. Lenders who provide debt consolidation loans give you a new loan to pay off the debts you’d like to consolidate. You still owe the same amount of money, but now, you only owe money on a single debt account held by a single lender. Debt consolidation loans generally have a less severe impact on your credit score than debt relief programs, like DMPs, do. 

Like DMPs, you can only consolidate unsecured debts. In some cases, lenders might allow you to move your debt onto a new secured loan. But this is risky because to secure the loan, you’ll have to put up some personal property, like your home, as collateral. If you default on the new loan, you can lose your personal property.

Each of the two main approaches to consolidation can impact your credit score. This is especially true of DMPs. According to credit bureaus, using a DMP is shows you’ve become overwhelmed by your debt, which is why it lowers your credit score. This is important because your credit score determines what kinds of loans you’re eligible for. If you’re struggling with debt and you’re not sure how credit reports and scores work, reach out to a financial professional like a credit counselor for help.

The Special Case of Student Loans

You can’t bundle student loans into a DMP, but you can consolidate them separately. Student loan consolidation has its pros and cons, especially if you’re consolidating federal student loans. Learn more about consolidating federal student loans in our guide.

When Is Debt Consolidation the Right Move?

Debt consolidation is not always the best debt relief strategy, but there are situations where it can really help.

If You Can Get a Lower Interest Rate 

One of the main goals of consolidating debt is to lower the overall interest rate on the debt you have so that you can lower the total monthly payments. For example, if you have three credit cards with interest rates above 10%, consolidating those three debts to a single loan at a 7% interest rate will likely lower your payments.

If You Have an Acceptable Credit Score 

To qualify for a good debt consolidation loan, you’ll need a decent credit score. Credit scores are divided into five categories: poor, fair, good, very good, and excellent. Before you consolidate your debt, make sure that your credit score is high enough to get good terms on your consolidated debt.

If You’re Confident You Can Pay Off the Debt

If you want to consolidate your debt, it’s important that you stick to the terms you’ve been given to pay it off. Missed payments can lead to late fees, have a negative impact on your credit score, and put you in a worse financial situation. If you don’t think you can make the payments, then debt consolidation may not be the best debt relief strategy for you. Still, you have other options

Pros and Cons of Debt Consolidation

Debt consolidation has many advantages. Chief among them is that consolidation makes your debt payments more manageable. If you’re able to consolidate at a lower interest rate, you’ll be able to lower your monthly payment as well. Debt consolidation can also help you improve your credit score by helping you improve your payment history. By removing the uncertainty and confusion of multiple monthly payments, you’ll be better prepared to make the correct payments on time. 

At the same time, debt consolidation is not for everyone. Remember that the consolidation won’t forgive or remove any of your debt. You’ll have the same amount to pay off. And in many cases, you may end up paying more money total because the consolidation will extend the length of the loan. Also, a successful consolidation requires a decent credit score. If you have a low credit score, consolidating your debt may not help you reduce your interest rate or monthly payment.

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What Is Debt Settlement?

Debt settlement happens when you agree to pay your lender (or creditor) a lump sum that’s less than what you owe and your lender agrees to accept it as payment in full on your debt. You can negotiate a debt settlement directly with your lender or use a debt settlement program and have a debt settlement company negotiate for you. 

Debt settlement can help you save money by paying only a portion of the amount you owed, but you can’t negotiate a settlement for every kind of debt. Generally, you can only settle unsecured debts, like credit card debt, personal loans, medical bills, and payday loans. Even though debt settlement programs won’t help you settle student loan debt, you may be able to negotiate a settlement directly with your student loan servicer.

When Can Debt Settlement Be Helpful?

Just as with all other debt relief strategies, there are pros and cons to settling debt. There are certain situations where the pros of debt settlement will likely outweigh the cons, including: 

  • You’ve exhausted all other options. If you’ve already exhausted all other debt-relief options and you’re still struggling with multiple debts, debt settlement may be the best next step. 

  • You don’t want to file for bankruptcy. Although bankruptcy can be helpful, you may not want to file for bankruptcy, and that’s OK. Debt settlement is a good alternative since it will help you reduce your monthly payments and overall debt. 

  • If your lender agrees to report the debt as paid, not settled. As a part of the settlement offer, lenders will sometimes agree to report to the credit bureaus that the debt was paid off as opposed to settled. Credit bureaus collect this kind of information to calculate your credit score. Debt that’s reported as settled will negatively impact your score.

Consequences of Debt Settlement 

Debt settlement has some drawbacks and consequences. First, the debt that lenders forgive in a debt settlement is generally considered income for tax purposes. So, if you settle your debt, you’ll probably have to pay increased income taxes. 

Debt settlements also usually involve additional fees, especially if you have a debt settlement company negotiate the settlement for you. If you’re considering debt settlement, you’ll want to calculate the total fee amount to make sure you have enough money on hand and to confirm that the fees aren’t more than the amount your lender will forgive.

Lastly, because debt settlements will be reported to the credit bureaus, going through with a settlement can lower your credit score. Even though you’ll be able to recover over time, debt settlements will remain on your credit report for seven years. 

Alternatives to Debt Settlement 

There are many ways to work on becoming debt-free and debt settlement may or may not be the best approach for your current situation. Before making your decision, consider the following alternatives: 

Hardship Programs 

Contact your loan servicer or creditor to see if they offer any hardship programs. In some cases, a loan servicer will be willing to refinance a personal loan to help you lower your monthly payments. Or your credit card company might approve you for a balance transfer credit card. Although balance transfers have transfer fees, their temporary low-interest rates can help you reduce your overall debt. 

Credit Counseling 

Consider meeting with a credit counselor to talk about your situation. Credit counselors, who usually work for nonprofit credit counseling agencies, can help you create a debt repayment plan that works for you. They’ll be able to discuss options like debt management programs, debt consolidation loans, debt settlement, and other debt-relief solutions.


Filing for bankruptcy can also help you if you’re dealing with overwhelming debt problems. As an individual, you can file for either Chapter 7 or Chapter 13 bankruptcy. 

In a Chapter 7 bankruptcy, you’ll be able to discharge most of your unsecured debts. Not everyone qualifies for Chapter 7 bankruptcy. In a Chapter 13 bankruptcy, your debts won’t be discharged, but you’ll be able to create a long-term repayment plan to pay off your debts. Each has its advantages and disadvantages, and not everyone qualifies for Chapter 7 bankruptcy.

Debt Consolidation vs. Debt Settlement

Debt consolidation and debt settlement both have similar advantages. They can both be used to get rid of high-interest debt, they both help you avoid late fees, and they also help you avoid having to deal with debt collectors.  

At the same time, these two debt reduction methods have three key differences.

1. Only debt settlement forgives debt.

Debt settlement reduces your total debt by forgiving a certain amount. Lenders often agree to debt settlements because they’re worried about not getting paid at all. Debt consolidation, on the other hand, does not reduce your total debt. It only bundles all your debt into a single payment so that it’s easier to manage.

2. You need more cash on hand for debt settlement.

Second, if you want to settle your debt, you need to have enough cash on hand to make the full lump-sum payment that your lenders or creditors agree to. With debt consolidation, you don’t need to have a lot of money on hand. In fact, the purpose of debt consolidation is usually to establish a lower monthly payment. 

3. Each method impacts your credit score differently.

Third, although debt settlement and debt consolidation can both impact your credit score, each affects it differently. A debt settlement will usually lower your credit score since it’s reported to credit bureaus and stays on your credit report for many years. Debt consolidation can also lower your credit score if you use a DMP since your participation is also reported to the credit bureaus.

In both debt settlement and debt consolidation, you can negotiate terms that reduce the impact on your score. With debt settlement, you can try to ask your lender to report the debt as paid off, rather than settled. With debt consolidation, you can try to get a debt consolidation loan instead of using a DMP. In either case, lenders don’t have to agree to these better terms, but it’s worth trying. 

Let's Summarize...

Both debt settlement and debt consolidation have benefits and drawbacks. And as debt relief solutions, they can both help you get out of debt. But they do so in different ways. Still, if you’re considering using either option, it’s important to first consider all of your options. Your options will depend on your credit score and how much and what type of debt you have.

If you’re not sure where to begin, talk to a credit counselor. Even your lender may be able to help you understand your options. And if you’re considering bankruptcy, we can help. Use our bankruptcy screener to see if you qualify.

Written By:

Natasha Wiebusch, J.D.


Natasha started her career as a lawyer representing labor unions and other investors in multi-state class action lawsuits. Passionate about the civil rights elements of her cases, she moved into practicing employment law to represent employees against discrimination of various ki... read more about Natasha Wiebusch, J.D.

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