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Debt Settlement or Debt Consolidation?

By: Michael Millington

Sometimes the sheer bulk of terms involved in the financial fields can get a bit daunting, even for people who have been in the industry for any length of time. One major source of concern for those outside the industry is the difference between debt settlement vs. debt consolidation. Though the two terms are actually quite similar in nature, there are some important differences to keep in mind.


The Difference Between Debt Settlement & Debt Consolidation

Perhaps the biggest difference between the two is the nature of debt that is addressed. Debt consolidation is mostly only involved when there is more than one debt to consider. Usually invoked to consolidate several smaller debts, a handful of larger debts, or even a combination of larger and smaller debts, debt consolidation satisfies the debts, commonly with a loan or credit line of some kind, which then becomes the only remaining debt outstanding. The instrument used to pay back the outstanding debts can range from a home equity line of credit to a credit card specifically geared toward individuals with low credit scores to even a debt consolidation loan.


Debt settlement, meanwhile, is an agreement between debtor and creditor which generally calls for the creditor to accept a sum that is less than the original debt (with the added inducement that the lesser sum is paid immediately in the form of a lump sum payment). This scenario isn’t always the case with debt settlement; sometimes the settlement might call for a reduced monthly payment or a longer term of total payments—the same amount spread out over 10 years instead of five, for example—but most often it’s a lump sum.


While a creditor is under no legal obligation to accept a debt settlement, it is viable solution to resolving debt for both the creditor and the debtor. The implication with a debt settlement is that the lump sum represents what the debtor can manage, and that failure to accept that sum may result in the debtor filing bankruptcy. In such a case, the creditor would possibly receive nothing so long as the credit line from the creditor was unsecured. By accepting the lump sum payment, the creditor gets some money back while the debtor gets an alternative to bankruptcy, which can do major damage to a credit rating for years. Debt consolidation, however, requires no input at all from a creditor. The entire process of debt consolidation is done with third-party interests.


What both debt settlement and debt consolidation have in common is that the two represent tools in the pursuit of rebuilding credit. While some are not so sure that debt consolidation works in the end—it requires a certain level of financial discipline that some may lack—it has been known to work on some occasions. Debt settlement does not always work since it requires the creditor to agree to new terms. Either way, the end result is the same: a way to address debt that’s running out of control in a fashion that gives all sides something they want. Debt settlement and debt consolidation are different tools, but both can ultimately accomplish the same thing and give those affected by debt badly-needed peace of mind.