Debt consolidation or debt settlement — what should you choose?

Credit card debt can be a tough problem to solve. And when you're researching solutions, you may come across certain ones that sound vaguely similar. Debt settlement and debt consolidation might be easy to mix up, but they both offer very different approaches to tackling debt.

CNBC Select explains how debt consolidation and settlement work, how to choose which is right for you and what other solutions to consider.

• What is debt consolidation?
• What is debt settlement?
• Is debt consolidation or settlement right for you?
• Other solutions to consider
• Bottom line

Debt consolidation is a method of debt repayment that involves combining multiple debts into one. This allows you to have a single monthly payment which can make it easier to stay on top of your bills. Plus, in the ideal scenario, you can save on interest payments.

There are a couple of tools you can use for debt consolidation. A balance transfer card, for instance, lets you move balances from other credit cards and avoid paying interest on the new combined balance for a specified amount of time. For example, the Wells Fargo Reflect® Card gives you a 0% APR on balance transfers and qualifying purchases for 21 months from account opening (18.24%, 24.74% or 29.99% variable APR thereafter). Note that with such cards, you'll need to pay a balance transfer fee on each transferred amount — the Wells Fargo Reflect, for instance, charges a 5% fee or $5 minimum.

A debt consolidation loan can also make your debts easier to manage. It's a personal loan designed for combining two or more unsecured debts. If you're approved for one, the lender will offer you an amount required to cover the debts. Many lenders even pay off your creditors directly. After that, you'll have a single fixed monthly payment with a fixed interest rate. Paying in installments makes for a predictable repayment schedule. And if your new APR is lower than what you've been paying before, you can also save on interest charges.

If your credit is in good shape, you're more likely to qualify for the lowest rates. CNBC Select recommends LightStream for borrowers with good or excellent credit. You can get same-day funding and there are no origination, early payoff or late fees.

And if your credit leaves a lot to be desired, Upstart can be a great option since it works with borrowers with a minimum score of 300 and even those with insufficient credit history.

Debt settlement (or debt relief) is the process of negotiating with your creditors to convince them to forgive a portion of your debt. You can choose to do it yourself or work with a debt settlement company that will negotiate on your behalf.

While the idea might sound appealing, debt relief is a risky endeavor. During this process, you stop making any payments toward your debt. Instead, you put your monthly payments in a savings account until you have enough to pay the sum that your debt settlement company and creditors agree on. However, while you're not paying, your creditors are likely to continue charging interest and late fees and report missed payments to credit bureaus. As a result, your credit score will potentially suffer long-lasting damage.

To add to that, there's no guarantee your settlement efforts will be fruitful. No company can promise you they'll be able to reach an agreement with your creditors, and if they tell you otherwise, it's most likely a scam. If you do go this route, it's crucial to watch out for fraudsters and work with a reputable provider. CNBC Select picked New Era Debt Solutions as the best overall debt relief company — it's been in business for over 20 years and has high rankings for customer service.

For most people, debt consolidation is the better choice. When comparing the two options, here's what to consider:

• With debt consolidation, you'll pay less in fees. Balance transfer cards typically charge a balance transfer fee of 3% to 5%. Some debt consolidation loans come with origination fees which can be up to 8%. But if you're working with a debt settlement company, you can expect to pay between 14% and 25% of the total debt you enroll.
• Debt settlement can harm your credit significantly. While negotiation is ongoing, you won't be paying your debts. All the missed payments will appear on your credit reports where they will remain for seven years. Payment history is the most crucial credit score factor, so multiple late payments might very well tank your credit. And even if the negotiation is successful, the credit bureaus will mark the accounts as settled, but with less than the full amount paid — which is still a negative entry on your report.
• Debt consolidation, on the other hand, can improve your scores. You might experience an initial small drop due to getting a new credit card or loan, but as you keep paying off the balance, you'll likely see positive changes. This is because you're improving your credit utilization ratio, another important credit score factor.
• You'll owe taxes on the forgiven debt. Most debt over $600 that's forgiven is considered taxable income and you'll need to report it on your annual taxes.
• Debt consolidation allows you to continue using your accounts once you pay them off. That's not the case with debt settlement since the lender will close the settled accounts.

Of course, that doesn't mean debt consolidation is always an ideal solution. Balance transfer credit cards often require good or excellent credit (or a FICO score of 680 or higher), so having a score on the lower end might result in a denied application. Some lenders offer debt consolidation loans for bad credit but will probably charge a high interest rate. And most importantly, debt consolidation requires discipline and patience. If you don't stick with the plan and instead keep adding to your debt, you risk finding yourself in an even worse situation.

Remember that there are multiple paths to debt repayment — you just have to find one that makes sense for you.

Often, all it takes is patience and dedication to the goal. You don't necessarily need any extra tools but you need a method. Whether you choose to focus on higher-interest debts or lower balances first, you can eliminate your debt on your own if you're consistent.

If you think you're past the point where you can figure out your debt yourself, you don't have to suffer alone. For instance, you can connect with a non-profit credit counseling agency where a certified counselor can analyze your financial situation. Your counselor may offer recommendations such as enrolling in a debt management program where the agency will create a payment plan with your creditors on your behalf.

Finally, there are legal tools, too. If you're drowning in debt and see no way out for years to come, bankruptcy is an option. Depending on the type, it can remove a certain amount of unsecured debt or get you into a repayment plan with better terms. Always consult with a credit counselor or bankruptcy attorney to determine whether it's the best approach for you.

Debt consolidation and debt settlement are two very different solutions to the same problem. Carefully analyze your situation to make the right choice and make sure to consider any additional options. Whatever you decide, discipline will be key to success. After all, it's hard to eliminate debt if you keep adding to it.

At CNBC Select, our mission is to provide our readers with high-quality service journalism and comprehensive consumer advice so they can make informed decisions with their money. Every credit guide is based on rigorous reporting by our team of expert writers and editors with extensive knowledge of credit products. While CNBC Select earns a commission from affiliate partners on many offers and links, we create all our content without input from our commercial team or any outside third parties, and we pride ourselves on our journalistic standards and ethics. See our methodology for more information on how we choose the best credit products.

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