When you combine two or more high-interest balances into one account, that’s debt consolidation. You can generally do this when your credit score and financial health are still good enough to get a personal loan or credit card that has a lower interest rate than your outstanding debt.

Out of the two options, this is the more attractive since you continue paying your debts in full and can avoid the credit damage associated with debt relief.

Debt relief, or debt settlement, is the process of hiring a third party agency to negotiate directly with your creditors to get them to accept a lower amount than you owe. Though this may get you out of debt faster, there are different costs involved, and typically significant financial ramifications as well. However, it can be an option for people whose debt has become unaffordable and who may no longer qualify for a consolidation loan or credit card with favorable terms.

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What’s the difference between debt consolidation and debt relief?

Debt consolidation reorganizes what you owe so you can repay it; debt relief attempts to reduce what you owe by negotiating settlements with your creditors.

Here’s where things can get confusing. Some companies advertise their services using terms like debt consolidation when what they’re actually offering is debt settlement. The Consumer Financial Protection Bureau specifically warns that some companies advertising debt consolidation services may actually be debt settlement companies.

There’s an easy way to spot the difference. If you’re taking out a new loan or opening a new credit account and using it to pay off your existing debts, you’re consolidating them. If a company is telling you to stop paying your creditors, put money into a dedicated account and wait while it negotiates settlements, you’re dealing with debt relief.

How debt consolidation works

Say you owe $20,000 spread across three credit cards, each charging a high interest rate. You’re still able to make your monthly payments, but a significant portion of your money is going toward interest charges.

If your credit is good enough, you might qualify for a $20,000 personal loan at a lower interest rate. You use that money to pay off all three credit cards, leaving you with one loan, one interest rate and one monthly payment.

Or, you might be able to transfer the balances to a credit card offering a 0% introductory APR period, so the entirety of payments during that intro period would go toward paying down the principal of your debt.

You still owe the full $20,000 in this scenario, but if the new loan or credit card has a substantially lower interest rate and reasonable fees, you could pay less in interest and have a clearer path toward paying off the debt.

How debt relief works

Now let’s take that same $20,000 balance, but imagine you’re in a different situation. You’re struggling to make the minimum payments, your credit has suffered and you can’t qualify for a consolidation loan or credit card with an interest rate that would actually help.

Instead of borrowing $20,000 to pay off your creditors, you hire a debt relief company and stop making payments on the debts you want settled. You put what money you can afford aside each month in a dedicated account while the company waits until you’ve accumulated enough to begin negotiating with your creditors.

The company then tries to convince each creditor to accept less than the full amount you owe. If a creditor agrees and you approve the settlement, money from your dedicated account is used to pay it.

Unlike debt consolidation, you may ultimately repay less than the original $20,000. But you’ll also pay the debt relief company a fee, and the missed payments and settlements should be expected to tank your credit score. If your creditors send the debts to collections, you could also be subject to repeated calls from debt collectors.

How costs, monthly payments and potential savings compare

Let’s continue with the same $20,000 spread across three credit cards. In this hypothetical, you’re making three monthly payments, each at a high interest rate.

With debt consolidation, those three payments become one. If you qualify for a lower interest rate, your new monthly payment might be less than what you’re currently paying, depending on the repayment term. More of your money can also go toward paying down the balance rather than interest.

Debt relief works differently. Instead of making monthly payments to your three creditors, you put an agreed-upon amount into a dedicated account each month. That amount may also be less than what you’re paying now. However, unlike consolidation, you’re no longer making payments on your debts while the debt relief company negotiates.

If the company reaches a settlement, it could ultimately reduce how much of the $20,000 you repay, but the savings aren’t guaranteed. Interest and late fees can accumulate while you wait, and whatever you potentially save through settlements will be reduced by the debt relief company’s fees.

It should also be noted your creditors have no legal obligation to settle, meaning it’s possible you could damage your credit, accrue late fees and/or have accounts sent to collections, and not ultimately succeed in reducing what you owe.

How each option can affect your credit

Debt consolidation can initially cause a small drop in your credit score when you apply for a new loan or credit card. But making your payments on time can help you build a positive payment history, and paying off your existing credit card balances can lower your credit utilization.

Debt relief can have a much greater negative impact. Because you typically stop paying your creditors while settlements are negotiated, missed payments can severely damage your credit. Settled accounts can also remain on your credit reports for years.

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The takeaway

The choice between debt consolidation and debt relief largely comes down to where you are financially. If you can still afford to repay what you owe and qualify for better terms, consolidation can give you a less expensive and simpler path out of debt.

Debt relief is for those in a different situation. If your debt has become overwhelming and repaying the full amount no longer seems realistic, accepting the costs and credit damage that come with debt relief may be worth considering in exchange for the possibility of settling what you owe for less.

A third path, which might be thought of as a middle ground, is working with an accredited nonprofit credit counselor to enroll in a debt management plan to repay what you owe.

To summarize, consolidation can make debt easier to repay. Debt relief can offer a way forward when repayment itself has become the problem.

Frequently asked questions

When might debt consolidation make more sense?

Debt consolidation may make more sense if you can still afford your monthly payments and your credit is good enough to qualify for a loan or balance transfer card with better terms. You still repay everything you owe, but a lower interest rate could make the debt less expensive and easier to pay off.

When might debt relief make more sense?

Debt relief may be worth considering when you can no longer keep up with your payments, repaying the full amount you owe doesn’t seem realistic and you can’t qualify for favorable consolidation terms. You may be able to settle your debts for less, but you’ll have to weigh those potential savings against fees, what will very likely be severe damage to your credit, and the understanding that your creditors are not required to accept settlement.

Can you consolidate debt with bad credit?

In theory, you may be able to consolidate debt with bad credit, but understand that qualifying for a loan with an interest rate low enough to save you money will be unlikely. And when it comes to balance transfer cards, issuers typically require that applicants have good or better credit for approval. Before applying for a loan or new credit card with the idea that you’ll consolidate debt, compare the new interest rate, fees and repayment term with your existing debts to make sure you’re actually getting a better deal. Avoid lenders with opaque terms and fees and steer clear of payday loans and such products.