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The Pros And Cons Of Debt Consolidation Vs. Debt Settlement

20Min Read
Updated: Oct. 9, 2025
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Written By
Sarah Edwards
Reviewed By
Jacob Wells

Struggling with debt? Feel like your credit card’s balances are always rising, no matter how many dollars you devote to paying them down? Are messages from collection agencies filling your voicemail? It might be time to turn to debt consolidation or debt settlement.

Both financial strategies can help you get your debt under control. But consolidation and settlement are not the same thing. If you consolidate your debt, you’re still responsible for paying it off over time. In debt settlement, the companies that you owe money to agree to eliminate at least some of your debt.

Which approach is right for you? This depends largely on the amount of debt you face and your ability to pay it off. Here’s a closer look at debt settlement vs. consolidation.

Key Takeaways:

  • Debt consolidation and debt settlement are both viable ways to move toward financial freedom.
  • If your credit is sufficient to get a good interest rate on a personal loan, debt consolidation is typically the better choice.
  • If you have poor credit, are behind on payments and want to avoid filing for bankruptcy, debt settlement may be best.
  • Always carefully weigh the pros and cons of debt consolidation and debt settlement before making your choice.

What Is A Debt Consolidation Loan?

Of these two options for dealing with debt, a debt consolidation loan is the more common solution.

In a debt consolidation loan, you take out a new loan with a lender and use the lump-sum payment from that loan to pay off your existing debt. You then pay back your new loan, with interest, in regular monthly payments.

The goal is to end up with one monthly payment that you can comfortably afford, hopefully at a lower interest rate than the ones attached to your existing debt. Before taking out a debt consolidation loan, make sure you can afford the payment each month. Missing a payment on this loan could devastate your credit score.

Debt consolidation loans are one of the better ways to pay off credit card debt over time. Most credit cards have fairly high interest rates – the average is around 24%, but some cards have rates of 30% or more.

If you have fair to good credit, you may be able to secure a consolidation loan with a lower interest rate than your credit cards. You’ll pay less over time, and you’ll also have to deal with just a single monthly payment instead of several smaller payments.

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What Are The Best Ways To Consolidate Debt?

Interested in debt consolidation? You have several options.

Personal Loan

A personal loan is one of the more common ways to consolidate debt. You’ll work with a lender to take out one of these loans, and you’ll receive a lump-sum payment once that lender closes the loan.

You can then use this money to pay off your existing credit card bills and other debt. You still must pay off your new loan with regular monthly payments. You’ll also have to pay interest on this loan. The goal, though, is that your new interest rate will be lower than the interest you’re paying on your existing debt, especially on your credit card balances.

Work with your lender to make sure that your personal loan’s monthly payment is one that you can afford. If that payment is too high, you’ll struggle again to pay off the new debt.

You’ll have to meet certain financial requirements to get a personal loan. Lenders will look at your credit score and monthly debts to make sure that you can afford your monthly payment and are likely to make your payments on time.

Home Equity Loan Or Home Equity Line Of Credit

If you own a home and you have equity in it, you can also consolidate your debt by taking out a home equity loan or a home equity line of credit (HELOC).

Equity is the difference between what you owe on your mortgage and what your home is worth. If your home is worth $350,000 and you owe $250,000 on your mortgage, you have $100,000 of equity. You can then take out a home equity loan or line of credit for a percentage of that, with a lender maybe approving you for a loan of $80,000. You’d pay that loan back in regular monthly payments with interest.

Home equity loans and HELOCs work differently. With a home equity loan, you’ll receive a single payment that you pay back each month. You can use that payment for whatever you like, including consolidating high-interest-rate credit card debt to a lower-interest loan. Home equity loans are a good choice to consolidate debt because they typically come with lower interest rates.

A HELOC works more like a credit card, with your home’s equity as its credit limit. With a HELOC, you have more flexibility in how much you borrow at a time. If you have a HELOC of $80,000, you might borrow $30,000 to consolidate your credit card debt. You then pay back only what you borrow, with interest. Again, homeowners turn to HELOCs to pay off credit card debt because these loan types come with lower interest rates.

Cash-Out Refinance

Homeowners with equity can also turn to a cash-out refinance to consolidate debt. In a cash-out refinance, you swap your current mortgage loan for a new one. But you also borrow more than what you owe on your current mortgage, using the extra cash for whatever you’d like, including consolidating debt with higher interest rates.

Maybe you owe $200,000 on your mortgage. Instead of refinancing to a new loan for that amount, you refinance to a mortgage of $250,000. You can then use the extra $50,000 to pay off your existing debt.

Remember, though, that you must pay back the full amount that you have borrowed, with interest. If you refinance for more than what you owe on your current mortgage, you will have to pay back a higher amount.

Balance Transfer Card

Several credit cards offer new cardholders a 12- to 18-month period during which they can transfer debt from their other cards to their new card with no interest. This gives cardholders the chance to pay off existing debt that previously came with interest rates of 19%, 20%, 22% or more without paying any interest at all.

This makes balance transfer cards a good choice for paying off debt. But you must be diligent about devoting extra money to paying down the balance that you’ve transferred. These 0% balance transfer offers don’t last forever. If you don’t pay off your transferred debt before the introductory offer expires, the leftover amount will be assigned your new card’s standard interest rate, which could be 20% or higher.

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What Are The Pros And Cons Of Debt Consolidation?

For many, debt consolidation is an attractive option for managing and ultimately reducing debt. However, it may not be the right choice in every situation. Before you take out a home equity loan or get preapproved for a debt consolidation loan, it’s important to take the time to consider the advantages and downsides.

Many people choose debt consolidation because it gives them greater control over their finances and (usually) substantially lowers the interest on their debt. However, most consolidation options come with fees, and if you aren’t careful, you could accumulate more debt.

Here’s a closer look at some of the main pros and cons of debt consolidation:

Pros Of Debt Consolidation

  • Money savings on interest paid: If you use a loan type with a lower interest rate, such as a personal loan, home equity loan or balance transfer, you can reduce the amount of interest you pay while tackling your debt. This is especially true if much of your debt is on credit cards. Credit card debt comes with some of the highest interest rates of any form of debt, often 20% or more. You might qualify for a home equity loan or personal loan with a rate that’s one-third to one-half that rate, depending on your credit.
  • Fixed payoff date: If you turn to a home equity loan, HELOC, a cash-out refinance or personal loan to pay off your debt, you’ll know exactly when that debt will disappear. That’s because lenders will provide you with a payoff schedule that lists your monthly payments, how much interest you’re paying and your loan’s payoff date. This gives you a tangible goal to work toward.
  • Fewer monthly payments: By consolidating your debt into one loan, you’ll reduce your number of monthly payments to just one. That’s easier to track than juggling five or more monthly credit card and other debt payments. Having a single payment makes it easier to create a budget and stick to it. It also offers peace of mind. Having one payment rather than several is a great way to feel more organized and in control of your finances.
  • Improved credit score: Taking out a debt consolidation loan will immediately cause at least a small hit to your credit score. That’s because you’re taking on a new loan, something that will cause your score to drop slightly. But this is only temporary. If you make your payments on time each month, you’ll steadily rebuild and possibly then increase your credit score. That’s because making on-time payments is the biggest factor in calculating your credit score. Reducing your debt will boost your credit score, too.

Cons Of Debt Consolidation

  • You’ll need good credit to qualify: You’ll need at least an average credit score to qualify for a personal loan or home equity loan with an interest rate low enough to make debt consolidation worthwhile. You won’t need an exceptional score, but most lenders will require a credit score in the low 600s or mid-600s to qualify for such loans. Your score might be lower if your high amount of debt has caused you to make late payments in the past.
  • Upfront costs: Lenders often charge upfront fees to originate personal loans, home equity loans, HELOCs or cash-out refinances. You might be able to roll these fees into your monthly payments, but be aware that debt consolidation typically isn’t free. Most refinances, for instance, cost 2% – 6% of your loan amount. If you owe $200,000, that comes out to $4,000 to $12,000, which you would likely roll into the amount you’re borrowing.
  • Larger single payment: Taking out a debt consolidation loan might also leave you with one larger monthly payment instead of several smaller ones. While that’s easier to keep track of, it might also be more difficult for you to pay, depending on how your income flows into your bank account each month. Maybe a portion of your income doesn’t hit your bank account before your larger monthly payment is due. It might be more of a struggle to make that payment on time each month.

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What Is Debt Settlement?

If you’re struggling with your debt, you can also turn to debt settlement services. With this approach, either you or a company that you hire negotiates with your creditors. The goal of these negotiations is to lower the amount of debt you owe or to eliminate it completely.

Say you owe $20,000 to three credit card providers. In debt settlement, you’d either call these providers yourself or work with a private debt settlement agency that would contact them for you. If you can show that you can’t pay all your debt but that you can repay some of it, your credit card providers might agree to lop off some of what you owe. Maybe instead of having to pay back $20,000, you’d be required to repay only $10,000.

The challenge is convincing your creditors to forgive some or all of your debt. The companies to which you owe money are under no obligation to forgive any of what you owe. Your best chance might be to convince these creditors that by forgiving a portion of your debt, they will at least receive some of what you owe.

What Are Some Debt Settlement Methods?

Consumers have three main options when pursuing debt settlement:

Doing It Yourself

The most affordable approach to debt settlement is to do it yourself.

To settle a debt, you must get in touch with the creditor and explain that you’d like to repay some of your debt but can’t afford to repay it all. Ask if the creditor is willing to eliminate some of what you owe and create a repayment schedule that works with your budget. Alternatively, you might ask if the creditor would accept a single lump-sum payment.

If you want to negotiate a debt settlement, don’t rush into it. Before contacting your creditors, take a close look at your finances and make a note of the following details for each debt:

  • The maximum lump-sum settlement payment you can afford
  • The maximum monthly payment you can afford (if you want to pay in installments)

You should have these numbers on hand when contacting your creditor, but never lead with your first offer. If a creditor is willing to let you settle a debt, they’ll likely want to do some negotiating before agreeing on an amount.

You can inquire about debt settlement over the phone or via email. Email has the advantage of creating a paper trail, but if you discuss this option over the phone, make sure you get the settlement agreement in writing before you pay.

The two most important points you’ll need to negotiate are whether you’ll pay a lump sum or installments and how much you’ll ultimately pay. However, you should also think about how you want to make a payment.

Many creditors will allow you to pay with an online bank transfer, and in many cases, this is the easiest option. Some may also accept wire transfers or paper checks.

Your creditors are not obligated to accept your offer. They might be more likely to erase part of your debt if you have already racked up several late payments. Providers might look at these missed payments and decide that receiving at least some money from you is better than receiving nothing.

Even if your creditors are not willing to eliminate any of your debt, they might agree to lower your interest rate or give you more time to repay without charging late penalties. Again, though, creditors aren’t required to do any of this. They might instead insist that you pay what you owe in full and on time.

Choosing For-Profit Debt Settlement

Don’t want to go the DIY route? You can also hire a private debt settlement company. These companies will negotiate on your behalf with your creditors, though they charge a fee. That’s part of the risk of working with debt settlement firms. They might charge high rates for their services, and there’s still no guarantee that they’ll be able to persuade your creditors to erase all or even part of your debt.

If you work with a private debt settlement company, it might request that you deposit money in an escrow account to save for future repayments. The company might also recommend that you stop paying your creditors. The theory is that these missed payments will encourage creditors to agree to a settlement because they would rather receive at least some payment from you.

This can be extremely risky. Even if you stop making your payments, your creditors might not agree to eliminate any of your debt. And by not making your payments, you are causing additional damage to your credit score while the amount that you owe keeps growing. You might also force your creditors to send your accounts to collection agencies. This will cause additional damage to your credit score. It will also open you up to phone calls and texts from these collection agencies.

To avoid running into unexpected fees, credit damage and additional stress, always move slowly when working with a debt settlement company. You should stop making payments on your accounts only if you fully understand the additional interest, fees and credit damage you may experience.

Be careful when choosing a debt settlement company. Some of the individuals or companies advertising their services in this industry are scammers happy to take your money while providing nothing in return. To increase the odds of hiring a legitimate provider, work with companies approved by the American Fair Credit Council (AFCC).

Using A Nonprofit Debt Management Company

You can also work with a nonprofit credit counseling service. These services work with consumers to help them manage their debt and develop repayment plans that they can afford.

With this approach to debt management, you might make a single payment to the credit counseling organization each month. The organization would then use this money to pay your creditors. This ensures that you won’t miss any of these payments.

Credit counselors (sometimes called debt counselors) rarely negotiate with your creditors to erase any of your existing debt. But they might work with your creditors to reduce your monthly payments. They might convince the companies you owe to increase the length of your loans, something that would lower your monthly payment. They might persuade credit card providers to lower your interest rate, another move that would reduce your monthly payment.

If you’re interested in working with a nonprofit credit counselor, search for companies approved by the National Foundation for Credit Counseling (NFCC) or Financial Counseling Association of America (FCAA).

What Are The Pros And Cons Of Debt Settlement?

If your debt has started to feel like a crushing weight that you’ll never get out from under, debt settlement can give you some room to breathe. Because you can resolve your debt by paying less than you owe, settlement enables you to eliminate your debt faster. It can also help you avoid the stressful bankruptcy process.

However, debt settlement won’t reduce what you owe without consequences. Because the debt will be marked as “settled” on your credit report, it will usually result in a drop in your credit score. It will also likely come with fees, which may decrease the total amount of money you save.

Before making this important decision, you should carefully consider the advantages and disadvantages of settling your debt.

Pros Of Debt Settlement

  • Owing less money: If your debt settlement efforts are successful, your creditors will eliminate at least some of the money you owe. This can reduce your financial burden.
  • Getting out of debt faster: If your creditors reduce your debt, you’ll pay back what you owe faster. This will lower the amount of interest you pay on your debt, something that could save you thousands of dollars, depending on how much you owe and how high your interest rates are.
  • You might avoid calls from debt collectors: If your creditors are working with you to settle your debt, they might be less likely to send your accounts to debt collectors. This eliminates the stressful calls or texts from these companies.
  • You might avoid bankruptcy: If your debts become unmanageable, you might have to file for bankruptcy protection, something that will devastate your credit. If you settle at least some of your debt, you might be able to avoid this drastic financial step.

Cons Of Debt Settlement

  • Loss of access to credit: If you agree to a debt settlement agreement with the provider of your credit card, you probably won’t be able to use that card again. Most debt settlement agreements come with the condition that your account will be closed. Many people don’t realize that debt settlement can also make it harder to access credit in the future, even from other lenders.
  • Less control over finances: If you work with a private debt settlement company, that provider will gain at least some control over your finances, dictating when you pay your creditors, how much you pay them and whether you deposit some of your dollars into an escrow fund dedicated to paying off your settled debt.
  • Added costs: Debt settlement typically isn’t free, especially when you work with a private firm. Make sure to include your provider’s costs when determining how much you’ll need to pay to eliminate your debts.
  • A potential drop in your credit score: If a lender closes your account after settlement, it will lower your credit score. Your credit score will also fall if you stop making payments to your providers before you close a debt settlement deal.
  • Owing taxes on forgiven debt: You might face a tax hit if you settle your debt. The IRS says that when debt is canceled or forgiven for less than what you owe, you must report the canceled debt on your tax return. You’d then have to pay taxes on this amount because the IRS considers it to be income.

Which Is Right For You? Debt Settlement Vs. Debt Consolidation

Deciding between debt settlement and debt consolidation? Debt settlement might be the better choice if you have a lower credit score and can’t afford your monthly payments. By working with your creditors to settle at least a portion of your debt, you might be able to avoid bankruptcy. You also might keep your accounts away from debt collection agencies.

If you have a stronger credit score, applying for a debt consolidation loan might be the smarter choice. Most lenders that originate home equity or personal loans require that borrowers have a credit score of at least 640, though this does vary. Make sure your budget can handle whatever new monthly payment you must make to repay your debt consolidation loan.

FactorDebt ConsolidationDebt Settlement
How It WorksDebt consolidation doesn’t reduce what you owe. But you might qualify for a lower monthly payment or interest rate.Your creditors might forgive at least a portion of your debt, reducing the amount that you owe.
Effect on Credit ScoreIf you make the payments on your debt consolidation loan on time each month, you’ll steadily improve your credit score.Your credit score will take a dip if your lender closes your account after debt settlement. Your score will fall, too, if you deliberately miss payments before negotiating a debt settlement.
Potential CostsLenders will often charge you closing fees when originating a loan. This varies, but when refinancing, closing costs can be 2% – 6% of your total loan amount.Private debt settlement companies don’t work for free. You might have to pay a fee of up to 20% of your total debt.
Credit Needed to QualifyYou’ll typically need a credit score in the mid-600s to qualify for debt consolidation.This is usually reserved for consumers whose credit scores are too low to qualify for debt consolidation options such as personal loans or home equity loans.
Tax ImplicationsTypically, there are no tax implications when you consolidate debt.The forgiven portion of your debt may be taxed as income.
Account Status After PayoffYour credit accounts remain open and usable.Your settled accounts are almost always closed.

You may wonder if you have debt reduction options beyond consolidation and settlement. Fortunately, there are many other choices. You might strategically pay down debt on your own with the help of budgeting tools or debt management plans.

If you need some guidance along your journey to financial freedom, consider hiring a credit counselor. Filing for bankruptcy may seem like a drastic option, but if you have more debt than you can repay and relatively few assets, it may be a way to get a financial clean slate.

Debt Consolidation Vs. Debt Settlement: FAQ

Questions about debt settlement vs. debt consolidation are common. Here are answers to some of the most common ones.

Debt consolidation and debt settlement are not the same. With debt consolidation, you’ll take out a loan – it could be a personal loan, home equity loan, HELOC or cash-out refinance – and use the funds from this loan to pay off your other debts. This will leave you with one payment that hopefully comes with a lower interest rate.
In debt settlement, you negotiate, either on your own or with a private company, a reduction in the amount you owe. Your goal is to convince your lenders or creditors to forgive at least some of your debt.
It’s possible to qualify for debt consolidation with bad credit. But if your credit score is too low, you may not qualify for an interest rate low enough on your new loan to make debt consolidation worthwhile. Debt consolidation makes sense only if the interest rate is lower than the rate on your current debt.
If you have bad credit and want to understand your options for reducing debt, consider seeking out a reputable credit counseling service.
Some companies that advertise debt settlement services will take your money and then do little or nothing to reduce your debt. To boost your odds of finding a reputable debt settlement company, look for firms approved by the AFCC or contact the office of your state’s attorney general for information about any debt settlement service you’re considering.
Bankruptcy can seriously damage your credit score. Depending on the type, a bankruptcy filing will remain on your credit reports for 7 to 10 years. That doesn’t mean that debt settlement is always a better solution. Filing for bankruptcy might help you gain control over your finances. If you’re considering bankruptcy, speak with a debt counselor or bankruptcy attorney first.

The Bottom Line: Find The Best Debt Reduction Option For You

Determining whether debt settlement or debt consolidation is right for you is no easy task. You’ll need to take a close look at your financial situation to determine which solution is the right choice. It’s recommended that you speak to an experienced financial advisor who can offer advice based on your specific situation and financial goals.

If you do decide on debt consolidation, a personal loan can help you get the money you need to pay off high-interest-rate debt. If you have a significant amount of equity in your home, a cash-out refinance or home equity loan may be a good option.

Sarah Edwards

Sarah Edwards

Sarah Edwards is passionate about financial literacy and helping readers overcome their money challenges. She has a talent for breaking down complex financial topics into clear, accessible language that resonates with everyday audiences. Her work regularly covers personal finance, law, real estate and small business. Sarah’s bylines have appeared in publications including Forbes, NerdWallet, Benzinga, and MoneyLion.

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