At a Glance
What’s the difference between debt consolidation and debt relief? With debt consolidation, you combine multiple debts—using a personal loan or balance transfer—to simplify your monthly payments, lower your interest rate, and/or pay off your debt faster. With debt relief, you can get your debt partially or fully forgiven or canceled. If debt relief seems too good to be true, that’s because it often is. That’s why it’s important to understand the differences between debt consolidation and debt relief, and the pros and cons of each.
What is debt consolidation?
Debt consolidation is a debt payoff method where you combine multiple debts into a single, lower-interest payment. Some common reasons you might consolidate debt include:
- To streamline your monthly bills
- To lower your monthly payments to create more disposable income
- To get out of debt faster
If you make your payments on time and don’t take on any additional debt, debt consolidation should not hurt your credit score. If you decide to apply for a debt consolidation loan, your score might drop temporarily because of the hard inquiry placed on your credit. However, if you’re able to repay your debt by consolidating, your credit should improve in the long term.
Ways to consolidate debt
There are several popular ways to consolidate your debt, including:
1. Personal loan for debt consolidation: A debt consolidation loan can help you lower your interest rate and secure more favorable terms, as long as your credit score is in good standing.
2. Balance transfer credit card: If you qualify for a balance transfer credit card, you might be able to transfer multiple debts to a new credit card, often with a low or 0% intro APR. But be sure to pay off that balance before your promo period ends, or else you’ll be stuck paying a higher APR on your remaining balance.
3. Home equity loan: A home equity loan essentially functions like a second mortgage and lets you tap into your home equity for easy access to money. Use this money to pay off your debt with a much lower interest rate.
4. HELOC: While home equity loans give you a lump sum, home equity lines of credit act as revolving debt, similar to a credit card.
5. Cash-out refinance: Replace your existing mortgage with a new one for quick access to cash and a lower interest rate.
6. 401(k) loan: Though we would never recommend this option, you can also tap into your retirement savings to help pay off your debt.
When debt consolidation is right for you
Since you’ll want to avoid taking on additional debt, debt consolidation makes sense if you have a budget and payoff plan in place. If you’re prepared, motivated, and disciplined with your finances, consolidating can help you knock out your debt and achieve your financial goals.
What is debt relief?
Debt relief is when you have your debt forgiven or canceled—either partially or in full. Sounds great, right? Well, not so fast…
The important disclaimer to be aware of is that people seeking debt relief are often desperate—which isn’t necessarily a bad thing—but that might make you easy prey for scammers. Before you choose a debt relief program, be sure to know:
- Potential fees
- Who you owe and how much money is being paid to those creditors
- Tax implications
One more note: If you have debt forgiven or canceled, your credit score might take a dip because those debts will appear on your credit report as settled and not paid (there’s a difference!).
Debt relief methods
Some common options for debt relief include:
- Credit counseling: Work with a nonprofit organization to help create a custom plan for repaying your debt. This plan will revamp your budget, as well as you how you manage money and credit. You just have to stick to it.
- Debt settlement: If you’ve already missed payments, you can settle your debt for less than the full amount you owe. In this case, you make a lump sum payment to the creditor (if they agree on the settlement). The thought is that they would rather have some of the money you owe them than none of it.
- Debt management: With a debt management plan (DMP), you repay your debts in full with a lower interest rate. DMPs have you make monthly payments to your DMP provider, who then negotiates with and pays your creditors on your behalf. You probably won’t be able to use your credit card accounts until you’ve completed the plan.
- Bankruptcy: A usual last-resort option, you can claim Chapter 7 bankruptcy to stop collection attempts, which requires you to surrender most of your property in exchange for discharge of your debts. This stays on your credit report for 10 years.
When debt relief is right for you
If you’re past the point of consolidating and need immediate relief, you might consider some of these options. Debt relief is typically best for delinquent debts—so, if you’ve missed payments and can’t seem to get a hold on your finances.
Now, your individual situation will dictate whether you need to simply restructure your debt with a DMP or seek forgiveness through debt settlement. Of course, if things are dire and you have multiple debts in the collections stage, bankruptcy is also an option.
Again, it’s important to remember that with any debt relief method you choose, your credit score will likely take a hit.
Debt consolidation vs. debt relief
While debt consolidation can be considered a method of debt relief (relief is a rather broad term), the two are very different in terms of options available and how they affect your credit.
If you want to lower your credit card utilization ratio and keep your credit score intact, debt consolidation might be the better option—as long as you’re confident you can keep up with monthly payments. If you’ve already tried consolidating, can’t keep up with payments, and aren’t super worried about your credit score, you can look into debt relief and settlement.
Want to see if debt consolidation is the way to go? Use our debt consolidation calculator to help estimate potential savings through consolidation.
FAQs about debt consolidation and debt relief
Does debt consolidation hurt your credit?
So, we know that debt settlement and bankruptcy can damage your credit score. But what about debt consolidation?
Truth is, when used effectively, debt consolidation should cause a temporary drop in your score but ultimately help you improve that number in the long run. When you apply for a new loan or balance transfer card to consolidate, you’ll get a hard inquiry on your credit, which comes with a slight hit to your score. However, with consistent, on-time payments and a reduction in your overall credit utilization ratio as you pay off your debt, your score should recover and rise.
If you end up accumulating more debt on your credit cards while trying to pay them off through consolidating, of course your score is going to drop. But that drop is more a result of errant spending than it is from consolidation.
Is debt relief a good idea?
Depending on your financial situation, debt relief can be a good idea if you select the right option. With so many methods to choose from, you want to make sure you understand where you’re at, as well as the potential impact your actions can have on your monthly budget, credit score, and long-term financial plan.
How do you choose the best debt relief program?
Whether you’re looking for credit counseling, a DMP, or a negotiator to help with debt settlement, you’ll want to do your own research. Make sure you’re working with professionals who are certified—scams are very common when it comes to debt relief and management, so make sure you can trust whoever you decide to work with.
Compare costs—upfront and hidden fees—and consider how you’ll have to change your financial behaviors to make your plan more effective.