Debt Consolidation vs. Debt Restructuring: Which is Right for You?

Get Personal Loan Rates

on LendingTree's secure website

Credit card debt is a way of life for many Americans. Total revolving debt balances were more than $1 trillion in the fourth quarter of 2018, according to the Federal Reserve.

With the cost of living rising and salaries not keeping pace, more people are racking up credit card debt to bridge the gap between income and expenses, said Kim Cole, community engagement manager of Navicore Solutions, a nonprofit credit counseling agency based in Freehold, N.J.

But while there are several ways to address burdensome debt, ranging from paying it off on your own to filing for bankruptcy, many people don’t know all of their options. Two possible solutions to address a heavy debt burden are debt consolidation and debt restructuring. In brief, debt consolidation results in one easy-to-manage payment, while debt restructuring results in paying a reduced balance.

What is debt consolidation?

Debt consolidation is the process of using a single larger loan to pay off a collection of existing debts, usually at a lower interest rate. There are a few consolidation methods available, such as using a Best Balance Transfer Cards with a low- or no-interest introductory period, obtaining a debt consolidation loan, or applying for a home equity line of credit (HELOC).

Cole cautioned, however, that using a HELOC is essentially moving your unsecured credit card debt to your mortgage. And, if you fail to make payments, your home is at risk. On the other hand, if you default on your credit card debt, it damages your credit score but doesn’t threaten your home.

Cole also pointed out that going through a debt management plan with a credit counselor is a form of debt consolidation. After a plan is established, debtors make one payment to the credit counseling agency and the agency disburses the funds to the creditors, sometimes at a lower interest rate if they can negotiate one.

The primary benefit of debt consolidation is the interest rate reduction. However, in order to qualify for a new loan or credit card, you need to have a good credit score. (Creditworthiness is not an issue in the case of a credit counselor’s debt management program, which isn’t a loan.)

Additionally, Cole pointed out a major pitfall of debt consolidation: It doesn’t address the underlying problem of overspending. Once the balance hits zero on their credit cards, many people will use the cards again to rack up new debt, leaving them in worse financial shape because they also have the consolidation loan to repay.

To avoid getting stuck in the same debt cycle repeatedly, you’ll need to examine and modify your spending habits. If you’re in a debt management program, you may be required to close your credit card accounts so you can get used to living a cash-based life, Cole said.

Advantages of debt consolidation loans

  • Lower interest rates resulting in less money to be repaid in total
  • Only one payment to manage

Disadvantages of debt consolidation loans

  • Good credit is required to secure a new loan or credit card
  • Consolidating the debt doesn’t address the underlying problem of overspending

What is debt restructuring?

Debt restructuring, also known as debt settlement, is the process of negotiating a reduced debt balance with creditors, said Mike Marsden, executive director of the San Diego-based nonprofit agency DebtWave Credit Counseling. If a creditor believes that they will never be paid in full, they may agree to receive a percentage of the balance due.

You can negotiate the new terms on your own or go through a for-profit agency for assistance. In either case, your debt needs to be severely delinquent before a creditor entertains a settlement.

And, if you’re thinking about using a debt settlement agency, be aware that they are expensive and there are risks involved. According to the Consumer Financial Protection Bureau (CFPB), the agency may have you stop making payments on your accounts to intentionally become delinquent. During that time, your creditors will pile on the penalties, the interest will keep compounding and your credit score will plummet.

Ultimately, the creditors are under no obligation to reduce your balance. If they refuse to work with the settlement agency, you’ll be stuck with a higher balance, worse credit and nothing to show for it. Additionally, the CFPB says that even if the settlement efforts are partially successful, the fees and penalties that you pay may negate any savings obtained in the settlement.

Further, while having part of your account balance erased may sound appealing, Cole warned that the forgiven amount could be considered taxable income.

Debt restructuring can be an appropriate solution if your accounts are already seriously delinquent and you have the funds available to make the settlement payments. Creditors will typically require the whole settlement amount to be paid as soon as a deal is reached.

The advantage of debt restructuring

  • Pay less than the full amount owed

Disadvantages of debt restructuring

  • Serious delinquency required to be eligible, which mars your credit
  • Forgiven amount of debt could be considered taxable income

Debt consolidation vs. debt restructuring

The chart below summarizes the difference between debt consolidation and debt restructuring.

Debt consolidationDebt restructuring
Financial standingYou may not be in financial trouble to use debt consolidation. Good credit score required to obtain the new loan.Typically reserved for when you’re in financial trouble. Accounts have to be seriously delinquent to qualify.
Credit score impactScore may increase if faithful payments are made on the consolidation loan.Score can sink because you default on your original promise to pay the creditor.
Monthly payment impactLower interest rates may lead to lower monthly payments.If debt is settled, the one-time payment will end the need for monthly debt payments.

Everyone’s financial picture looks different. Therefore, you need to choose a debt relief strategy based on your situation and budget. You should explore all available avenues and avoid rushing into anything. There’s usually a good fit for everyone — you just have to figure out the right path.

Comments and Questions

The editorial content on this page is not provided or commissioned by any financial institution. Any opinions, analyses, reviews, statements or recommendations expressed in this article are those of the author’s alone, and may not have been reviewed, approved or otherwise endorsed by any of these entities prior to publication.