Weigh Your Options: Debt Settlement vs. Debt Consolidation

If you are considering debt settlement vs. debt consolidation, your personal situation and priorities will dictate your ultimate decision. Settlement means negotiating a sum to pay down your debt with no remaining obligation. This sum is typically lower than the amount remaining on the loan if it were paid off in full. Consolidation may involve settlement, but it is focused on paying off multiple loans with one large loan. There are unique benefits and penalties to each.

Settling Debts Separately

One option if you have multiple outstanding debts is to settle them each separately. This may be a good choice if you anticipate multiple, smaller cash gifts or bonuses in the coming year. As you receive these small amounts of liquidity, you can use them to negotiate an immediate settlement with one lender at a time. This is also a good strategy if your debts have very different interest rates. You will want to settle the highest-interest debts first. You may not benefit from combining debts with such different rates because you will have to consolidate to a middle ground rate, in effect making some debts more expensive.

Consolidating Debts

If your debts have relatively similar rates, though, you may be able to consolidate them without making a compromise on interest rate. You can pay them all down at once, immediately reducing your total debt. Having only one payment a month toward the new consolidated loan instead of multiple payments helps you organize your debts and assure nothing slips through the cracks. Consolidation is a good option if your debts exist in one area. For example, you can consolidate student loans from many years of undergraduate and graduate education into one student loan. In the future, this student debt can be arranged and monitored much more easily.

Penalties to Settlement

Whenever you settle debt, the initial lender is losing money. Lenders protect themselves from this loss with two key strategies: fiscal penalties and credit penalties. Settlement removes a lender's chance to apply appropriate fiscal penalties. You are settling down a debt without even paying full interest, and you will not likely then agree to pay thousands of dollars in fees. Since this is not an option, the lender will have to rely on credit penalties to show you did not resolve the debt in a satisfactory manner. Your score will drop significantly, and the settlement will be noted on your credit history for years to come.

Penalties to Consolidation

During consolidation, all of your creditors, instead of just one or two, will be penalizing your credit score. The result can be damage nearly as large as declaring bankruptcy. Thankfully, it is easier to recover credit after consolidation than after declaring bankruptcy. However, you will still find it is nearly impossible to get any significant loan in the near future. You should not consolidate within 5 years of seeking an automobile loan or mortgage loan. If you do, those future loans will have very high rates. When you consolidate, talk to the consolidation lender about a credit repair strategy to help recover from the problems as fast as possible.

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