A:

Debt consolidation and debt settlement are both financial strategies for improving personal debt load, but they function quite differently and are used to resolve different issues. At a very basic level, debt settlement is useful for reducing the total amount of debt owed, while debt consolidation is useful for reducing the total number of creditors to whom you owe debt. It is possible to receive secondary benefits through either strategy, particularly debt consolidation.

Debt Consolidation

You consolidate your debts through a consolidation loan, which is a single loan that combines and replaces all of your prior debts into one monthly payment with one interest rate. Consolidation loans are offered through financial institutions, usually banks or credit unions, and all of your debt payments are made to the new lender.

For some, the psychological benefits of having a simplified, consistent monthly payment is enough to warrant a debt consolidation strategy. In some circumstances, a consolidation loan might result in a lower total monthly payment or a lower average interest rate on your debt. This can be offset through extended repayment terms, so be sure consider the long-term costs of consolidation loans.

Most consolidation loans are secured with one of your assets, such as your home, car, retirement account or insurance policy. Only accept a secured consolidation loan if you are comfortable with putting up considerable collateral.

Debt Settlement

A debt settlement strategy does not seek to replace existing debt with a new loan, as with consolidation. Instead, debt settlement is a series of negotiations between your creditors and you (or a credit counselor) to make payments – usually lump-sum payments – for amounts less than you currently owe.

Creditors are under no obligation to enter negotiations or accept your offer. Nevertheless, it is often possible to pay much less than you currently owe if the creditor believes that your offer represents the creditor's best chance to recoup the loan. Advanced debt collection techniques and accounts receivables processes can be expensive, and fighting through a bankruptcy proceeding is unattractive to most lenders. The process is not usually completed after one round of communication; in fact, stretching out the debt settlement process is a common strategy to force a creditor's hand.

Settled debt is gone – wiped clean. With unsecured debts such as credit cards, you risk having your account closed completely after the settlement is complete because the lender does not want to continue to grant you credit.

Contact the Federal Trade Commission or the National Consumer Law Center for free information on debt negotiation and debt negotiators.

Either strategy can have lasting impacts on your credit score, so be sure to weigh the pros and cons of each action carefully before undertaking either debt consolidation or debt settlement.

RELATED FAQS
  1. What's the difference between debt consolidation and debt management or debt settlement?

    Learn about different ways of handling debt when you become overwhelmed, including debt consolidation, debt management and ... Read Answer >>
  2. What are some examples of debts that I can consolidate?

    Read about different kinds of debts than can be combined into a consolidation loan, including unsecured debts, secured debts ... Read Answer >>
  3. Will my credit score suffer from debt consolidation or refinancing?

    Learn how different debt relief options – consolidation, settlement, credit counseling and bankruptcy – could affect your ... Read Answer >>
  4. How can I consolidate my unsecured debt?

    Discover some of the different ways that you can combine your present unsecured debts into a consolidation loan -- even by ... Read Answer >>
Related Articles
  1. Investing

    7 Ways To Consolidate Debt

    Different loan sources to use when you consolidate debt.
  2. Taxes

    A Lifeline For Those Drowning In Debt

    Don't wait to be saved, find out where the lifesaving devices are and hang on tight!
  3. Financial Advisor

    The 4 Best Debt Reduction Services

    It can be tricky to find the best debt reduction services for your financial situation. These top 4 debt consolidation firms help make the process easier.
  4. Personal Finance

    Unemployed? 5 Smart Ways to Get Control of Debt

    When you're unemployed and barely making ends meet, smart debt advice can help you stay on top of your payments and protect your credit rating.
  5. Taxes

    Debt Consolidation: When It Helps, When It Doesn't

    Here's the smart way to use a debt consolidation to get your financial life back on track
  6. Personal Finance

    Best 5 Money-Saving Tips to Get out of Debt

    Understand the different types of debt and the reasons why people get into debt. Learn about five tips to follow to get out of debt.
  7. Personal Finance

    Time To Consolidate Your Student Loans?

    Use these strategies to decide whether consolidating your student loans makes sense for you – and what to do next if it does.
  8. Personal Finance

    How to Invest When You're Deep in Debt

    Debt is one of the biggest obstacles that prevents people from investing - but it shouldn't be.
  9. Personal Finance

    4 Debt-Busting AlternativesTo Balance Transfers

    Credit card balance transfers can help pay off debts – but they can cost you. Here are some other approaches worth checking out.
  10. Personal Finance

    Will Paying Off Old Debt Boost Your Credit Score?

    Learn why paying down your debts may not always be the fast-track to improving your credit score.
RELATED TERMS
  1. Debt

    An amount of money borrowed by one party from another, often ...
  2. Debt Service

    The cash that is required for a particular time period to cover ...
  3. Net Debt

    A metric that shows a company's overall debt situation by netting ...
  4. Secured Debt

    Debt backed or secured by collateral to reduce the risk associated ...
  5. Debt Snowball

    A method of debt repayment in which debtors pay off their smallest ...
  6. Re-Aging Debt

    Restarting the clock on a debt’s statute of limitations.
Trading Center