Debt Settlement vs. Debt Consolidation: Which one is right for you?

You've probably heard both of the terms "debt settlement" and "debt consolidation." You may have thought of them as interchangeable. In fact, they have very different meanings. You need to first understand what they mean to decide which one is right for you.

Debt Consolidation. This is a term that simply means combining all of your debt into one loan or one payment. Where it can get complicated is in choosing a method of debt consolidation.

You can choose a home equity loan, borrowing against retirement accounts, personal loans, or balance transfers to low-interest credit cards.

Typically, when you consolidate your debt you'll pay lower interest and have lower monthly payments. In many cases you'll also pay your debt off faster than when you had many separate accounts.

Debt Settlement. This is a term that refers to using a third-party to help take care of your creditors. Usually this is through a consumer credit counseling service. Your counselor will work with your creditors to close your credit accounts.

Your counselor will also work with your creditors to help lower your interest rates and reduce finance charges. They will also aid in ending collection calls for your debt.

Through settlement, you don't actually receive a loan to consolidate your debt; rather you send one payment to a third party that distributes the money to your lenders.

Credit counseling companies don't report anything to credit bureaus. However, your creditors may report that you are paying your debt to them through a consumer credit counseling service.

Making the choice. Choosing between consolidation and settlement will largely depend on your current credit rating. If your credit is good or you are a homeowner with a lot of equity in your home, you will benefit more from consolidation loans.

If your credit is blemished and you don't have collateral for a secured loan, settlement may be a better option for you. In this situation, paying your debts in any way will improve your credit rating.

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About the author:

Michael Torrance is a financial consultant with First American Debt Consolidation and Loans, a company specializing in debt consolidation loan alternatives through consumer credit counseling.