Debt consolidation Vs debt settlement – how different are they and which one should you choose? This guide will explain the differences between these two debt strategies, providing clarity so you know which one is more suitable for your situation.
For further help and support, speak with one of the fantastic UK debt charities.
What is debt consolidation?
Debt consolidation is when someone with debts reduces the number of their debts by taking out new credit and using the money to pay off multiple other debts. For example, you might have three loans and take out a debt consolidation loan to pay off all three loans. In a nutshell, you lump all of your debt together.
The benefit of this is it makes keeping up with monthly repayments easier with less chance of overspending or missing frequent repayments. Moreover, finding credit with a better interest rate than you’re currently paying could save you money.
The four common ways to consolidate debt are:
- Using a debt consolidation loan
- Using a balance transfer credit card (to consolidate other credit card debts only)
- Debt Management Plans (DMPs)
- Remortgaging or getting a second charge loan and using the home equity to repay existing debts
What is debt settlement?
Debt settlement is when the debtor and the creditor agree to settle the debt early with one payment. This usually involves the lender “forgiving” a percentage of the debt. For example, if the debtor owes the creditor £1,000, they could make an offer to settle the debt for £800. The other £200 would then be written off and would not need to be paid.
It’s essential that you get any debt settlement agreement in writing before making a payment.
How to negotiate a debt settlement
If you decide to negotiate a debt settlement, you usually have three options:
- You can negotiate the debt settlement yourself
- You can ask a charity to help you negotiate
- You can use paid-for debt settlement companies
You should be wary of a debt settlement company claiming they can get a better deal than you would be able to negotiate. The end decision is down to the creditor and it’s unlikely that a paid-for service will get a significantly better agreement – if at all.
Investopedia suggests starting your offer as low as 30% of the outstanding balance. However, most debt settlements are in the region of 70% so expect counter offers as the negotiations progress. If you manage to get any money wiped off the balance owed and you can afford it comfortably, you should see this as a victory.
Is debt consolidation the same as debt settlement?
Debt consolidation and debt settlement are two different debt management strategies. Whereas one tries to move all of the debt into one place while reducing interest payable, the other tries to clear an individual debt while getting some of the balance written off.
However, there are some similarities between debt consolidation and debt settlement. They are both strategies that can reduce the debtor’s number of debts and the total amount of debt owed. And they are both typically used as an early intervention.
Debt consolidation vs debt settlement
Debt consolidation and debt settlement can both be beneficial. The difference between using debt consolidation and debt settlement comes down to personal circumstances. Debt consolidation is a method used by people who want to get a grip on spiralling finances, or by those that just like to grab a cheaper deal.
On the other hand, debt settlement is usually used by people who have debts and have suddenly come into money, maybe through new employment or inheritance. It is used as a way to save while paying back what is owed. However, it has implications on your credit score, which we discuss further down this guide.
Debt consolidation and debt settlement at the same time
You might be wondering if you could use both at the same time. For example, could you take out a debt consolidation loan to pay off multiple debts, and then try to reduce the amount you have to pay back on the individual debts to clear them.
This is possible. But you should get any debt settlement offers in writing before you apply for the debt consolidation loan or balance transfer credit card. Don’t apply for a loan or credit card to consolidate debt in hope that your creditors will allow you to settle for less. Doing so could cause financial difficulty and a worsening debt problem.
How much does debt consolidation affect your credit score?
When you apply for a debt consolidation loan or a balance transfer credit card, the lender you apply to has to complete a hard search of your credit score. This doesn’t have a substantial impact on your credit score, but if you were to apply for lots of loans or credit cards in a short space of time, it would. Debt consolidation will not negatively affect your credit file. You would damage your score if you didn’t keep up with repayments on the new debt.
How much does debt settlement affect your credit score?
Settling a debt for lower than its value will negatively affect your credit score. When you repay credit it shows up on your credit history as “satisfied”. But when you settle a debt for less than what is owed, it shows up as “settled”. Banks and lenders will be able to see that you did not repay what was owed in full for the duration it remains on your file, which is six years.
This is something to keep in mind when you weigh up debt consolidation vs debt settlement.
FREE debt advice for you!
You might instinctively know whether to choose debt consolidation or debt settlement based on what is financially possible in your situation. But if you need further support and guidance, and even to discuss other debt solutions, speak with a UK debt charity, Step Change and National Debtlien are just two of the best, offering free and confidential debt advice across the UK.