Debt consolidation vs. Debt settlement

If you’re dealing with unmanageable debt, know you’re not alone. According to a 2025 Workplace Wellness Survey, nearly three quarters of American workers believed their current level of debt was a problem.¹

If you’re looking for a way forward, knowing the difference between debt consolidation and debt settlement — and the long-term implications of each — could help you make a more informed decision as you chart your financial future.

What is debt consolidation?

Debt consolidation is an approach to paying off multiple debts by which you combine them into one, more manageable monthly payment. Debt consolidation could lead to lower monthly payments or help you save money on interest if you qualify for a lower interest rate.

There are many ways to consolidate debt. In this article, we’re focusing on personal loans and credit card balance transfers.

Personal loan

A personal loan is a lump sum of money you can borrow from a lender, bank or credit union and repay in predictable monthly payments, with interest (the cost of borrowing), until the loan is paid off. You can use a personal loan to pay off multiple debts. Some lenders may call this a debt consolidation loan.

When you consolidate your debts into one loan, you should have one monthly payment with a fixed interest rate. Your payments will stay the same each month, which could make it easier to manage your budget.

Personal loans have a set payoff date, so as long as you make your monthly payments on time, you’ll know exactly when your debt will be fully repaid. A personal loan may also offer a lower interest rate or lower monthly payment amount than your current debts.

However, it’s important to note that if you opt for a debt consolidation loan with a longer repayment period than your existing debts, it could mean paying more in interest over time, even if your monthly payment is lower. And it’s important to keep in mind that to get the most benefit from a debt consolidation loan, it’s a good idea not to take on additional new debt.

Credit card balance transfers

A credit card balance transfer lets you transfer your existing credit card debt to a different credit card, typically with a low promotional interest rate. For example, a balance transfer offer might feature an introductory or promotional 0% annual percentage rate (APR) on transferred balances for a certain period of time, usually 12 to 21 months.² After the promotional period ends, the APR on any remaining balance will rise to the regular non-promotional rate. To make the most of a balance transfer offer, it’s a good idea to pay off as much of your transferred balance as you can before the low-APR period ends. You may have to pay more than the monthly minimum to meet your goal.

While you can also make new purchases with the credit card you’ve used for the balance transfer, it may get in the way of your goal to pay down your existing debt. Also, the low APR you received for balance transfers may not apply to new purchases, meaning those purchases would accumulate interest at the higher, non-promotional rate if you don’t pay that balance in full and on time every month.

What is debt settlement?

Debt settlement is a process of negotiating with creditors to reduce your debt. One of the most common ways to try to settle debt is to arrange for a debt settlement agency (DSA) to negotiate on your behalf for a fee. Other options include hiring an attorney or contacting lenders directly.

It’s important to know that debt settlement, especially with a DSA, is risky. It can cause long-lasting harm to your credit score, you may owe taxes on the portion of your debt that was waived, you may wind up in more debt than you were before and results aren’t guaranteed.

Here are the three most common ways to try to settle debt:

DIY debt settlement

If you want to try to settle your debt yourself, you can contact your creditors directly to try to negotiate a lower payoff amount. DIY debt settlement may save you money on fees, but some creditors may not work with you, depending on their policies. The process takes time, patience and confidence to handle on your own. If you succeed, you may need to have enough money saved up to offer a lump-sum payment to each creditor.³

Debt settlement agency (DSA)

DSAs are for-profit companies that sell debt settlement services. They’re different from credit counseling organizations, which are often nonprofit organizations that help clients budget for and manage debt. For a fee — which can be high — DSAs will try to reduce how much you owe by negotiating with your creditors. The DSA may ask you to stop making payments to your creditors while they negotiate. Instead, you would make monthly payments into a savings account held by the DSA, called a trust account. If the DSA is successful, it pays your creditors using the money in the trust account.

Attorney debt settlement

Hiring a lawyer to settle debt can be costly and isn’t usually necessary. However, you may consider it in some situations. For example, if a creditor has threatened to sue you over unpaid debt, an attorney could help you understand your rights, confirm whether you owe the debt and, potentially, push for a settlement.⁴

Debt settlement risks

Successful debt settlement could mean you pay less than what you owe while helping you avoid lawsuits and possibly bankruptcy.⁵ However, debt settlement tends to come with risks for many borrowers. Here are some factors to consider first.

Settlement isn’t guaranteed

Not every company will work with a DSA and not every debt is eligible for settlement. Typically, creditors will only consider settling a debt under exceptional circumstances, such as when an unpaid debt is very old.⁶ And even if the creditor is willing to negotiate, there’s no guarantee a DSA will be able to reduce any of your debt. You could still face late fees and penalties for missed payments without getting the relief you were promised. Finally, if the DSA settles only part of your debt, it can still collect that portion of its fee as soon as the first payment is made. For example, if the DSA settles 50% of your debt, the DSA could charge you 50% of its total fee.⁷ In this case, you could find that paying the DSA’s fee takes away from how much money you have to pay down your remaining debt.

Effects on credit score

Debt settlement typically causes a large, immediate drop in credit scores, sometimes over 100 points.⁸ The hit to your credit can happen for a few reasons:

• Missed payments: DSAs often require you to stop making payments to your creditors while they negotiate a deal.⁹ The longer your debt goes unpaid, the more your credit score could suffer.
• Delinquent accounts: If you stop making regular monthly payments, your account could be considered delinquent or potentially be charged off.¹⁰
• Settled status: The account is typically reported to credit bureaus as “settled” rather than “paid in full.”¹¹ As with other negative debt activity, settled debts stay on your credit report for seven years.¹²

Potential for increased debt

When you stop paying your creditors, you could be charged late fees even if you’re working to settle the debt. Some may also charge a higher penalty annual percentage rate (APR) after too many missed payments. The combination could increase your debt, rather than reduce it.

Potential charge-offs

Debt settlement can take between two and four years.¹³ But once your payments become 120 days past due (or more), the lender could close your account and write off the debt as a loss, known as a charge-off. After a charge-off, you’ll still be legally responsible for the debt.

A charge-off will appear on your credit report for up to seven years. If the creditor sends the unpaid debt to a collection agency, that will also stay on your credit report for seven years — even if you ultimately settle or pay the debt.¹⁴

Tax implications

Debt settlement may involve debt forgiveness. The IRS usually considers forgiven debt to be taxable income. There are some exceptions, but in most cases, you’ll need to report the canceled debt as income on your tax return.¹⁵ The creditor may send you an IRS Form 1099-C, Cancellation of Debt to file with your income taxes. Form 1099-C is a tax form that shows the amount of canceled debt and the date of cancellation.¹⁶

Impact on future borrowing

Even if you do settle your debts, you could wind up with major, long-lasting, damage to your credit score. Having settled debts on your credit report will likely make it hard to get approved for credit cards, mortgages, auto loans and other types of credit in the future. If you do get approved, lenders may charge you a higher interest rate.¹⁷

Debt settlement scams

Unfortunately, scams are common in the debt settlement industry. If a DSA promises results that sound too good to be true, it’s likely a scam. Other potential red flags to watch for include: ^{18, 19}

• Guaranteeing all or partial debt relief
• Advertising a “new government program” for debt relief
• Using pushy sales tactics or rushing you to make a decision
• Asking you to pay fees up front, before the DSA settles any of your debts

Don’t provide any financial or personal details without checking the legitimacy of the company.

What’s the difference between debt consolidation and debt settlement?

With debt consolidation, you combine your debts into one new loan or credit card with regular monthly payments. Debt settlement, on the other hand, means negotiating with creditors to pay less than you owe, typically in a lump sum. Each option has its own considerations.

	Debt Consolidation	Debt Settlement
How it works	Combine multiple debts into one new loan or credit card account	Negotiate to pay creditor an amount lower than the full amount owed
Outcome	Repay 100% of the principal plus interest	Original debt may or may not be reduced; costs could outweigh savings
Potential costs to consider	Interest charges and fees for a new loan or credit card	Significant DSA fees, late fees, penalty APRs and possible income tax owed on forgiven amount
Credit impact	May cause a small credit score drop for up to a year,20 but lowering credit utilization and paying on time can help in the long run	Settled debts and DSA recommendations can cause a significant negative impact that typically stays on credit reports for up to seven years

Which option might work best for me?

The way you choose to manage unwanted debt could impact your finances for years to come. Before making a decision, know that debt consolidation and debt settlement are very different options.

In most cases, attempting debt settlement probably isn’t worth significantly damaging your credit score. If your debt has become unmanageable, you might feel that the chance to reduce how much you owe is tempting. However, it’s important to evaluate the risks of debt settlement before moving forward.

On the other hand, a responsibly managed debt consolidation loan or credit card balance transfer could be a better fit than debt settlement if the following reasons apply:

• You’re seeking a lower interest rate or lower monthly payment.
• You have several unsecured debts like credit cards or secured debts, like a secured personal loan and want to combine them into one monthly payment.
• You’re prepared to make regular monthly payments to pay off the balance.

Other strategies for paying down debt

If you aren’t ready to consolidate or settle debts, you could consider trying one of these debt repayment methods instead to help you get back on track.

Credit counseling

Nonprofit consumer credit counseling services (CCCS) can help you come up with a plan to get out of debt, typically at little to no cost. For example, a CCCS may be able to set up a debt management plan that can help you pay off certain types of debt, such as credit card debt, in three to five years. A CCCS typically does this by negotiating with creditors on your behalf to try to lower your payments, reduce your interest rate or waive fees. You then make monthly payments to the CCCS, who pays your creditors on your behalf. Unlike debt settlement, following a debt management plan with a credit counselor may have a long-term positive effect on your credit score.²¹

To avoid potential scams, it’s a good idea to make sure your CCCS is approved by the U.S. Trustee Program of the U.S. Department of Justice. You can also reach out to one of OneMain’s recommended Certified Nonprofit Credit Counselors to help you create a debt repayment plan that works for you.

DIY debt repayment strategies

If you don’t want to work with a credit counselor, you could try a debt repayment strategy. Two common ones are the debt snowball and debt avalanche methods.

With the debt snowball method, you pay the minimum on all your debts but put extra money toward the smallest debt first. After paying off the first debt, you use the money you were putting toward that debt to tackle your next smallest debt.

The debt snowball method works well if you’re feeling overwhelmed by multiple smaller debts like store credit cards or medical bills. Paying off smaller balances first gives you motivating quick wins, helps reduce stress and builds the momentum you need to keep going on your debt payoff journey.

With the debt avalanche method, you pay the minimum on all your debts but put extra money toward the debt with the highest interest rate first. After paying it off, you focus on the debt with the next-highest interest rate until all debts are repaid in full.

If you’re carrying high-interest debt, the debt avalanche method might be a good fit for you. By targeting the most expensive debt first, you could pay less interest over time and shorten your overall repayment period.

Remember that for both of these methods, you need to continue making at least the minimum monthly payment on all your other debts.

Manage debt on your terms

Even when debt seems overwhelming, it’s not too late to regain control of your finances. But it’s important to take the time to weigh your options first. Debt settlement may do more harm than good for many people, and other options may better fit your situation. Whether you take out a debt consolidation loan or choose another method, the goal is the same — to manage your debt in a way that makes sense for your budget and lowers your stress.

Sources

1 https://greenwaldresearch.com/survey-majority-of-workers-worry-about-credit-card-debt
2 https://www.bankrate.com/credit-cards/zero-interest/zero-percent-intro-apr-guide/#how
3 https://www.debt.org/settlement/diy-debt-settlement/
4 https://www.bankrate.com/credit-cards/advice/what-to-do-when-sued-for-credit-card-debt/#lawsuit
5, 9, 10, 11, 17 https://www.experian.com/blogs/ask-experian/debt-settlement-risks/
6 https://www.cbsnews.com/news/how-debt-relief-companies-negotiate-settlements-with-creditors/
7 https://www.creditkarma.com/debt/i/debt-settlement
8, 21 https://www.nfcc.org/blog/debt-relief-programs-the-pros-and-cons-of-each-type/
12 https://www.experian.com/blogs/ask-experian/how-long-do-settled-accounts-remain-on-a-credit-report/
13, https://www.cbsnews.com/news/how-long-does-credit-card-debt-relief-take/
14 https://www.experian.com/blogs/ask-experian/how-long-do-charge-offs-stay-on-your-credit-report/
15, 16 https://www.irs.gov/taxtopics/tc431
18 https://www.aba.com/advocacy/community-programs/consumer-resources/protect-your-money/loan-modification-and-debt-relief-scams
19 https://www.consumerfinance.gov/ask-cfpb/what-is-a-debt-relief-program-and-how-do-i-know-if-i-should-use-one-en-1457/
20 https://www.experian.com/blogs/ask-experian/does-applying-credit-cards-hurt-credit/