Debt consolidation vs. debt settlement: Which is better?

Managing multiple debts can be overwhelming, especially when interest rates are high and repayments are scattered across different lenders. If you’re struggling with repayments, two common strategies to regain control are debt consolidation and debt settlement.

Both options aim to reduce financial stress, but they work in very different ways. One focuses on restructuring debt into a more manageable loan, while the other seeks to negotiate a reduced payoff amount. Choosing the right solution depends on your financial situation, credit standing, and long-term financial goals.

This guide breaks down how debt consolidation and debt settlement work, their pros and cons, and which option might be the better fit for you.

Table of Contents

What is Debt Consolidation?

Debt consolidation involves combining multiple debts into a single loan with a lower interest rate or more manageable repayment terms. This makes it easier to track payments, reduces interest costs in some cases, and simplifies financial management.

How Debt Consolidation Works

You take out a new loan (such as an online loan, a personal loan, balance transfer credit card, or home equity loan) to pay off existing debts.
Instead of managing multiple repayments with different interest rates and due dates, you make one repayment each month.
If the new loan has a lower interest rate than your previous debts, you can save money over time.

Types of Debt Consolidation

1. Personal Loan for Debt Consolidation

Borrow a fixed sum to pay off multiple debts.
Repay the loan in fixed instalments over 2 to 7 years.
Interest rates depend on your credit score and income stability.

Example: If you have three credit cards with a combined debt of $15,000 at 20% interest, taking out a personal loan at 9% interest could reduce your interest payments and make budgeting easier.

2. Balance Transfer Credit Card

Move existing credit card debt to a new card with a 0% interest promotional period (usually 6-24 months).
Pay off the debt within the promotional period to avoid high post-introductory rates (can jump to 20%+ if unpaid).

Example: If you owe $5,000 on a credit card with 18% interest, transferring it to a 0% balance transfer card for 18 months allows you to repay without accruing additional interest—provided you clear the balance before the promo ends.

3. Home Loan Refinancing (Using Equity)

If you own property, you may be able to refinance your home loan and borrow extra funds to pay off debts.
Mortgage interest rates are much lower than personal loan or credit card rates.
However, extending your mortgage term means paying more in interest over time.

Example: A homeowner with $20,000 in high-interest debt might refinance their mortgage at 5% interest instead of paying 20%+ on credit cards.

Pros of Debt Consolidation

Lower interest rates (if you qualify for a competitive loan)
Easier repayment management with a single monthly payment
Fixed repayment timeline for personal loans
May improve credit score by reducing credit utilisation

Cons of Debt Consolidation

Requires a good credit score to access the best rates
Does not reduce the total debt amount (you still owe the full amount)
Balance transfer cards can backfire if debt isn’t cleared before the promo ends
Mortgage refinancing increases long-term interest costs if repayments are extended

What is Debt Settlement?

Debt settlement involves negotiating with creditors to accept a lump sum payment that is less than the total debt owed. This can be done independently or through a debt settlement company.

How Debt Settlement Works

You or a debt settlement company contact creditors and propose a reduced payout amount.
Creditors may agree to write off a portion of the debt rather than risk getting nothing if you default.
The lump sum is paid, and the remaining balance is forgiven.
The settled debt is marked as “paid, settled” on your credit report, which can impact your credit score.

Example: If you owe $20,000 in unsecured debt (credit cards, personal loans) and can offer $12,000 in a lump sum, creditors might accept it to recover at least part of the amount.

Pros of Debt Settlement

Reduces the total debt amount (often by 30-50%)
Can provide financial relief faster than paying in full
Avoids bankruptcy, which has more severe long-term consequences

Cons of Debt Settlement

Severely damages your credit score (settled debts remain on credit history for up to 5 years)
Creditors aren’t obligated to accept a settlement
Requires a lump sum payment, which can be difficult to arrange
Debt settlement firms charge fees, which can reduce overall savings

Key Differences: Debt Consolidation vs. Debt Settlement

Feature	Debt Consolidation	Debt Settlement
Goal	Simplify repayments and reduce interest	Reduce the total debt owed
Impact on Credit Score	Can improve credit score (if payments are made on time)	Damages credit score (settled accounts are marked negatively)
Repayment Method	A new loan with structured repayments	Lump sum or negotiated repayments
Savings Potential	Saves on interest but full debt remains	Reduces total debt, but may involve extra fees
Long-Term Effects	Keeps financial history intact	Stays on credit report for up to 5 years
Best for	Those with a steady income and decent credit	Those in serious financial hardship

Which is the Better Option?

The best choice depends on your financial situation, credit standing, and long-term goals.

Choose Debt Consolidation If:

You have good credit and qualify for a lower-interest loan.
Your main problem is high interest rates, not unmanageable debt levels.
You want to simplify repayments and avoid credit damage.
You have a steady income and can commit to repayments.

Choose Debt Settlement If:

You are in severe financial distress and cannot keep up with payments.
You have no realistic way to repay your full debt.
Your credit score is already poor, and you’re willing to take a hit.
You can secure a lump sum payment for negotiations.

Alternative Debt Solutions

If neither option seems ideal, consider these alternatives:

Debt Agreements (Part IX Agreement) – A legally binding arrangement under Australian bankruptcy law to repay a portion of your debts over time.
Financial Counselling – Free services like the National Debt Helpline (1800 007 007) offer expert guidance.
Hardship Assistance – Contact creditors to negotiate lower repayments if you’re struggling temporarily.
Bankruptcy – A last resort that clears debts but has severe financial consequences.

Debt consolidation and debt settlement each have benefits and risks. If you have a manageable debt load and good credit, consolidation is usually the better choice since it keeps your credit intact and reduces interest costs.

However, if you’re in deep financial trouble and can’t afford to repay the full amount, settlement may be an option—but be prepared for a credit score hit and potential difficulties securing future loans.

Before making a decision, consider seeking professional financial advice or speaking to a free debt counsellor to explore your best path forward.

Debt consolidation vs. debt settlement: Which is better?