Debt Settlement vs. Debt Consolidation

Debt Settlement vs. Debt Consolidation

Debt settlement and debt consolidation are two financial approaches that help you to better manage the load of debt that you have. However, each program follows different functions and methods. 

At a rudimentary level, debt settlement is beneficial for lowering the total amount of debt being owed, while debt consolidation is advantageous for lowering the total number of creditors that you are indebted to. It is possible to receive secondary benefits through both approaches, especially in debt consolidation.

What is Debt Settlement?

Debt settlement is when you negotiate with your creditor to pay off a debt for an amount that is less than what is being owed. The debt settlement process is typically used to settle a huge amount of debt with one creditor, however, it may also be used to deal with several creditors. 

What is Debt Consolidation?

Debt consolidation is an effort to combine debts from several creditors, then take out a single loan to pay them all, hopefully at a reduced interest rate with a  lower monthly payment. This is typically done by consumers trying to keep up with bills for multiple credit cards and other unsecured debts.

The pros and cons of debt settlement and debt consolidation differ, especially relating to the amount of time it will take to eliminate the debts and the impact it will have on your credit score. Both of these approaches aim to make your debt more manageable. When used properly, either one of them can help you get out of debt sooner and save money. 

The Pros and Cons of Debt Settlement

Debt settlement could be advantageous for you if you are trying to eliminate debt because it gives you the prospect of paying far less than what you owe. In a debt settlement, you or the credit agency representing you gives an offer to your creditor. The offer is normally an amount lesser than what is owed. For instance, offering to pay a lump sum payment of $8,000 for a $16,000 debt. If the creditor agrees to accept the proposal, then the payment is made and the debt is considered to be settled.

If you are contemplating partnering with a debt settlement agency to negotiate your debts for you, you might want to consider the following points: 

  • Add-ons

Ask your agency about any miscellaneous fees, late fees, interest rates, or penalties that you may incur while the settlement negotiation takes place.

  • Credit Score

Missing out on payments while you’re in the process of negotiating with your creditors could take a toll on your credit score. Consult with your debt settlement agency on how you can go about your settlement negotiations while causing minimal damage to your credit.

  • Opposed Creditors 

Some lenders might not agree to settle as they’re not obligated to accept settlement offers. 

For people who feel helpless with their debt state and do not want to declare bankruptcy, debt settlement could be the short-term answer. However, if there are still other open options to help you manage your debts better versus opting for debt settlement, then debt management would be a better choice. 

The Pros and Cons of Debt Consolidation

Debt consolidation could be an advantage for you if you’re feeling overwhelmed by the multiple payments you have and you’re looking to streamline your debts with simpler repayment options. 

Credit cards are the number one source of financial constraints for a lot of consumers. There is approximately $16,000 of credit card debt for an average American who owns at least 4 credit cards, excluding bills for utilities, rent, mobile, etc. 

Credit can be a good thing, however, slight mismanagement in paying off your monthly dues can be an arduous struggle to catch up with. Debt consolidation is a great debt relief option when it reaches a point where you’re only able to pay the minimum payments for your bills. 

With debt consolidation, the advantages are pretty obvious: You make one big-time loan to pay off all of your other debts and focus on one single loan. No multiple payments, no multiple lenders. 

Consolidating your debts also constitutes a cost-saving benefit because your new loan should have a lower interest rate, a lower monthly premium, and longer repayment terms as compared to the combined cost of the bills that you have consolidated. 

The disadvantage of getting into a debt consolidation program is that the amount of debt that you owe remains the same, it is not eliminated or reduced. You still basically owe the same amount of money, you’re just paying for it in a more simplified way. 

Types of Debt Consolidation

There are many ways for you to consolidate debt. Each one differs in terms, requirements, and associated fees: 

  • Personal Loans – A lot of debt consolidation companies, banks, or online lenders offer personal loan options when combining debt. The interest rate for a personal loan is usually given at a fixed rate and is expected to be lower than what is commonly charged on credit cards. The downside to getting a personal loan, however, is that it also comes with charges such as pre-payment penalties and could sometimes require collateral.

  • Debt Management Plan (DMP) – Debt Management Programs usually involve education programs and credit counseling to help you identify the root of your financial dilemma and formulate a solution that you can act on as soon as you are done with the course. However, DMPs usually require time and perseverance as it takes about 3-5 years to eliminate the debt.

  • Balance Transfer – If you have an excellent credit score, particularly one that does not exceed 700, then zero balance transfers could work for you. Zero balance transfers are offered by credit card companies and normally involve expiration dates for 0% offers as well as transfer fees of 2-3%.

  • Home Equity Loan – Home equity line involves home collaterals but normally has a relatively lower interest rate. 

Before you decide, you might need to carefully examine each of the routes available for consolidating your debts such as coming up with the overall cost of debt consolidation, determining the length of time it will take for you to finish the loan, and how it can impact your credit score.

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