Why Debt Consolidation May Be a Better Choice Than Debt Settlement

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Are you hesitating between debt settlement and debt consolidation? Read this first.

Key points

  • With debt consolidation, you get a new loan with better terms.
  • With debt settlement, you negotiate an amount to pay with your creditors.
  • Debt consolidation doesn’t hurt your credit or affect taxes like settlements can.

Owing money can be very stressful. If you find yourself with a large outstanding balance, chances are you want to pay it off as soon as possible. However, it can be difficult to manage and understand how. There are a few approaches you can take, but two common techniques are debt consolidation and debt settlement.

To help you choose between the two, here’s what you need to know about how each works and why, for many people, debt consolidation is a better choice.

How does debt consolidation work?

Debt consolidation involves using a new loan to pay off several existing debts. For example, you could take out a personal loan and pay off three credit cards and a few medical loans with it. Or you can use a credit card balance transfer and move the outstanding amount charged on multiple cards to a new balance transfer card.

Typically, debt consolidation doesn’t just combine your debts, it gives you a new loan with more favorable terms. For example, you could find a personal loan at a lower interest rate than your current creditors and use it to consolidate your debts. And it would reduce financing costs and make repayment easier and cheaper.

How does debt settlement work?

Debt settlement is not like consolidation. You don’t get a new loan. Instead, you make a deal with the creditors you already owe money to. Typically, they agree to accept less than what you currently owe, thus settling your debt for less than the full outstanding balance.

Debt settlement can consist of making a lump sum payment or entering into a repayment plan. Often, debt settlement companies will offer to negotiate a settlement for you with your creditors, but you can also do this yourself by working directly with your creditors. This saves you the fees charged by specialist debt settlement companies.

Why is debt consolidation a better choice?

Debt consolidation is generally preferable to settlement for a few key reasons.

1. Consolidation won’t damage your credit, but debt settlement will

More often than not, creditors won’t agree to settle your debt until you’ve been behind on your payments. And they’ll report your debt as settled, rather than paid in full. Both can hurt your credit score.

Consolidation doesn’t hurt your score that way, and it can improve it in the long run if you show you can pay off your consolidation loan on time.

2. You don’t need creditor permission for consolidation

You can only settle a debt if your creditors agree. But as long as you can get approval for a consolidation loan, you don’t need permission from your current creditors to do so.

3. You are sometimes taxed on settled debts

Being taxed on a settled debt can impact your IRS bill. And in some cases, it could push you into a higher tax bracket, which would mean you end up owing a good amount of money. Depending on how those calculations break down, it might not be worth settling debt if you can consolidate instead.

Think carefully about what is best for your situation when deciding how to pay off your debts. But, often, you will find that consolidation is the right option for these three important reasons.

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