Debt Settlement vs. Debt Consolidation: Which is Better?

Feel like your debt is crushing you? You’re not alone. In fact, the average American household debt is over $100,000 as of the end of 2024. However, that doesn’t mean you don’t have options for getting out of debt.

Two options that can help you make significant strides toward getting out of debt include debt consolidation and debt settlement plans. Here, we’ll take a deep dive into both of those options, exploring their benefits, drawbacks, and an alternative that takes the best from both without the risks.

What Are Debt Consolidation Loans?

A debt consolidation loan lets you pay off existing debts, such as credit cards, medical bills, and personal loans, using a new loan. It combines—or consolidates—all of your debts into one monthly payment. In many cases, this can lower your interest rate across the scope of all debts. For some people, debt consolidation loans can help you pay off debts faster, at a lower cost, and improve your credit score.

While you may be able to get a specific debt consolidation loan, you can also consolidate debt with several other types of widely-available loans. Popular choices for debt consolidation include:

• Home equity loans: Home equity loans use the value of your home’s equity as collateral.
• Personal loans: Personal debt consolidation loans, though harder to obtain, do not require substantial collateral to secure them.
• Balance transfer credit cards: A single credit card with a higher balance could allow you to transfer credit card debts to a single card.

One major factor influencing which route you take for debt consolidation is the interest rate. Interest rates for debt consolidation loans vary based on whether collateral is used to secure the loan, your credit score, and your income.

The more collateral you can use to secure the loan, the better your credit score, and the higher your income, the more favorable interest rate you’ll get. Conversely, unsecured loans, a poor credit score, and low-or-no income will lead to a higher interest rate.

Benefits of Debt Consolidation

Consolidating your debt from multiple credit cards, personal loans, or other debts into a single loan with just one payment can provide numerous benefits, including:

• Simplifying your payments, which makes budgeting easier and reduces the likelihood of missing your payment (and hurting your credit score as a result)
• Fixed repayment timeline, depending on the type of loan, instead of an ongoing, endless credit card
• Potentially lower interest rate depending on the new loan qualifications

Drawbacks of Debt Consolidation

There are some limitations to debt consolidation loans, including that:

• They may require substantial collateral like home equity to qualify
• Refinancing for a longer term could cost you more over time, even if you get a lower interest rate
• Credit score requirements can be high, which can limit debt consolidation loans’ accessibility
• Consolidating debts without changing your spending habits could lead to even deeper debt

Understanding Debt Settlement

Debt settlement is the process of working with current creditors to settle your debt for less than you owe. In many cases, a third-party organization helps negotiate a payment or payment plan that’s less than your total current balance.

Debt settlement companies will facilitate the process, building a relationship with the lender on your behalf. Often, an agreement is made for you to make either a fixed payment or a series of payments. Once those payments are made, the remainder of the debt is forgiven.

The timeline for the debt settlement process ranges based on the agreement set up. Often, these programs allow consumers to pay off their debt within three to four years, though some could be shorter.

While you typically end up paying less than you owe with debt settlement, there are additional costs involved. The debt settlement company typically charges a fee for their service and an ongoing fee for processing payments. These fees can range from 15-25% of the total debt you owe.

Benefits of Debt Settlement

Debt settlement provides a number of potential benefits if you’re unable to make payments on your debts as you originally agreed to. Some of the benefits include:

• Potential for significant debt reduction: In many cases, debt settlement companies can reduce what you owe by 50% or more, depending on the type of debt and other qualifications
• Alternative to bankruptcy: While debt settlement does not eliminate all of your debt, it can significantly lower the amount owed, making it possible to get out of debt over time
• Shorter repayment timeline: Most debt settlement programs aim to help you become debt-free within 3-4 years (and sometimes sooner) depending on the amount of debt
• Stop creditor harassment: Entering into an agreement with the lender alleviates harassing calls and frustrations since the debt settlement company becomes the intermediary

Risks and Downsides of Debt Settlement

At this point, debt consolidation might sound like a magic bullet. However, there are significant downsides to be aware of before you jump into a debt settlement agreement:

• Severe credit score impact: You can expect an enormously detrimental impact to your credit score because you’re not meeting the terms of the loans you’ve initially agreed to. Credit scores often takes more than five years to recover from debt settlement
• Tax implications: The IRS may require you to report the amount of debt you had discharged as income, which can increase your tax burden in some situations
• No guarantee of success: If you don’t fulfill your promise with the lender or they decide not to continue to move forward with the settlement, the agreement can fall through, and you may still owe the full balance
• Potential for legal action: If you stop making payments, lenders could seek legal action against you, including attempting to recover assets

Tips For Making the Right Choice

Debt settlement and debt consolidation are two very effective tools for getting out of debt, though with very different formats, outcomes, and implications for your financial health moving forward. To determine which is best for you, consider the following:

• What is your current debt situation? Do you need help reducing your monthly payment but have good credit? If so, you may benefit from consolidation. If you can’t pay off all of your debt, settlement may be a better route.
• How’s your credit health? If your credit score right now is quite low because you are missing payments, consolidating may not be an option. Debt settlement may allow you to start rebuilding your score sooner.
• What are your financial goals? If you want to be debt-free sooner and are not worried about your credit score, a settlement could offer a faster route to take. Consolidation is better in the eyes of building a strong financial credit history and demonstrating your obligation to make payments as you promised.
• Additional warning signs to watch for: Learn as much as you can about the company you work with, including what their financial rating is, what their fees are, and what services they provide. Look at reviews to help you compare your options, and avoid the temptation to rush into things.

Debt Settlement vs. Debt Consolidation Side-By-Side

Get the Best of Both With SKYDAN’s Sale-Leaseback

If your credit score isn’t strong enough for debt consolidation options, but you don’t want to destroy it with a debt settlement plan, you might feel like you’re trapped. Fortunately, you don’t have to be.

SKYDAN’s sale-leaseback program gives you the best of both worlds, letting you tap your home’s equity regardless of your credit score to pay off your debts quickly. Here’s how it works:

1. SKYDAN buys your home, but you don’t move out.
2. You then agree to lease your home back from us. We set a mutually-agreed upon amount, not exceeding 2 years.
3. Rent is deferred until the end of the agreement, so no monthly payment is due.
4. Finally, at the end of the agreement, you have two options, so you’re never stuck.
1. Purchase your home back at SKYDAN’s original purchase price plus deferred rent.
2. You sell your home at its current market value and receive all additional equity.

With SKYDAN, you could have cash-in-hand within 30 days of qualifying. Get started in less than three minutes to see if you qualify!