Debt Consolidation vs. Debt Settlement



Personal consumer interest rates are very low right now.  This presents an opportunity for many of us to take advantage of refinancing our personal consumer debt, in an effort to obtain a lower interest rate and lower overall payment.  It is common to hear the terms debt consolidation and debt settlement used interchangeably, but they are in fact quite different.


With debt consolidation, you essentially combine all of the debt into one new loan with a new creditor.  For example, if you owe $5,000 to credit card A, $3,000 to credit card B, and $2000 to credit card C (a total of $10,000), you have 3 different payments, due on different dates, and all with their own interest rate.  Consolidating this debt will involve you contacting a new creditor, such as a local bank or online debt consolidation lender, and asking for a new loan to cover the amount of your total consumer debt – in this example – $10,000.


  • Having 1 payment instead of 3 certainly makes things easier to track, and is less time consuming.
  • There is only one interest rate for the entire amount of debt, and given the current low rates, you could save a lot of money.
  • There will be a more definitive end in sight, as you choose the terms of the new loan: 3 years, 5 years, etc.


  • Consolidating your credit entails opening a new line of credit. 10% of credit scores comes from new credit, so this may cause a slight “hit” to your score.
  • If you open up a new line of credit for the exact amount you need to consolidate all of your consumer debt, then you just maxed out your new line of credit. Initially, your credit score will take a hit because of this.  However, this will improve over time as long as you make timely payments.
  • Some lenders require that you close out the accounts being paid, which is important to know before making a decision. By closing these accounts, you may be erasing some good credit history, which can also lower your credit score. On the flip side, if you leave these accounts open, there may be the temptation to continue using them, further increasing debt.


Consolidating your personal debt may be a great idea, as long as you manage it properly.  I often recommend using a comparison tool such as  It’s free and easy to use.  This tool will allow you to compare a debt consolidation offer to what you’re currently doing, in an effort to determine if a consolidation actually makes sense for you.


Settling personal consumer debt is often done through a so-called “debt relief company,” which works to negotiate with creditors on your behalf.   The goal is to obtain a lower interest rate, or ideally principal forgiveness on your current balances.


  • You may end up paying less that what you actually owe.
  • The hassle of negotiation is taken off of you, and done by the debt settlement company instead.


  • You have to pay the debt settlement company directly, not your creditors. As a result, your creditors often don’t get paid for months while the debt settlement company negotiates with them.  This may result in a significantly negative impact on your credit score, as you are basically defaulting on multiple payments.
  • Creditors may send you to collections, or file a judgement against you in court and sue you. This may even result in your paycheck being garnished.
  • If a creditor settles with the debt settlement company for a lesser balance that what you owe, you may end up getting a 1099-C at the end of the year. The “C” stands for cancellation.  If $600 or more of debt was cancelled, the creditor is required to issue this document and send a copy to the IRS.  Let’s say you initially owed $10,000 in credit cards and the settlement company got that lowered to $6,000 (a difference of $4,000).  The 1099-C will be in the amount of $4000 which is considered taxable income by the IRS.  Now, you may not have to end up paying taxes on this if you are considered insolvent, but you would need to consult with a tax professional or CERTIFIED FINANCIAL PLANNER™ professional to help make that determination.


While you may end up paying less through debt settlement than you would have without it, there may be negative consequences to your credit score.  Be sure to read the fine print and consult with a CERTIFIED FINANCIAL PLANNER™ professional, to help make the best decision for you.


Now!  Some people are under the assumption that you have to be rich to have a financial planner.  There are others who believe they only need to speak with a financial planner if they’re having a serious financial issue.  Neither is true.  Regardless of your economic situation, a financial planner can help you in truly significant ways.  Whether you have a lot of money, a little bit of money, a lot of debt, no debt, unsure about your employer’s 401K options, or any other money related issue, a financial planner can help you navigate through all of these things and put you on the road to achieving your financial goals.  Even if you feel very stable with your finances, a financial planner can help you sustain the progress you’ve already made.


Listen to the On My Way To Wealth Podcast for additional information and specific examples. Want to receive my e-book with free money tips for Gen Xers? Click this link:  Consult with a Certified Financial Planner™ professional as he/she can provide you with the knowledge and expertise critical to help you Build A Better Financial Future!


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