Debt consolidation vs. debt restructuring: Which one is best for you?

Managing debt is stressful, particularly when the amount you owe is more than you can pay off in the foreseeable future. Even minimum monthly payments can be overwhelming. That’s when the debt consolidation vs. debt restructuring conversation usually begins.

These two strategies are similar but not identical. Debt consolidation requires a debt consolidation loan, whereas debt restructuring is more of a negotiation process. There are pros and cons to each, but the end goal is the same: getting you out of debt.

What is debt consolidation?

Debt consolidation is all about reducing interest rates and increasing the amount of time you need to pay off your total debt. Simplified, it means the consumer takes out a loan for the total amount owed on high-interest credit cards and other debts, then pays them all off.

You’re basically trading all your other monthly payments for one single, monthly loan payment. That’s a convenience for sure, but it’s much more than that. Interest rates on consolidation loans can be significantly lower than credit card interest rates, so you save money in the long run.

Loan terms can run three to five years if you need them to. Be careful when you negotiate, though. Stretching it out longer means that you’ll be paying more in total interest payments. The ideal strategy is to pay off the loan as quickly as possible.

There will be a slight negative effect on your credit score when you first take out the loan, but there will also be a corresponding positive boost when your credit card balances go to zero. Overall, a debt consolidation move should increase your FICO score.

What is debt restructuring?

Debt restructuring is a different animal. Instead of taking out a loan, you reach out to your creditors and attempt to negotiate the amounts owed. This sometimes involves stopping all monthly payments, which could have a significant short-term effect on your credit score.

There are debt restructuring agencies that can handle the negotiations for you. Most of them will have you deposit a certain amount of money into their account each month to use for settlement offers. They estimate what those settlements are likely to be.

Unlike debt consolidation, there’s no guarantee that your creditors will accept a settlement offer, but most will if they don’t receive a payment for an extended period. Credit card companies often settle for as little as 40% of the total debt.

You’ll end up paying less in total debt when you choose the restructuring route. In the process of negotiating, your credit score will go down, but eventually it will come back up when your debts are paid.

Which is the right choice for you?

Debt consolidation is cleaner and easier. Creditors get the full amount owed and there’s little danger of any long-term negative effect on your credit score. With debt restructuring, you pay less but settlements may cause a negative mark on your credit report.

It boils down to risk versus reward. If you’re willing to gamble a good credit rating for reduced debt, go with debt restructuring. To keep your credit score intact and stretch out debt payments with a lower interest rate, debt consolidation is the right choice.