Debt Settlement vs Debt Consolidation: Which is Better?
Debt settlement and debt consolidation are two of the main options available for debt relief and have helped millions of Americans save billions of dollars over the years. You can significantly reduce and even clear your debt, but these options are not straightforward, and they don’t come without their fair share of risks.
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In this guide, we’ll look at the ways that a debt consolidation loan and a debt settlement program can impact your credit score, while also covering the advantages and disadvantages.
Debt Settlement vs Debt Consolidation
Consolidation and settlement programs are some of the most popular and effective forms of debt relief. They can both help you escape the clutches of debt, but they work in completely different ways and help debtors in different situations.
What is Debt Settlement?
When you hire a debt settlement company they will negotiate with your creditors on your behalf. The goal is to reduce the size of your debts by offering these creditors a lump-sum settlement in exchange for complete discharge.
If you have $10,000 worth of credit card debt, for instance, the debt settlement company might offer $5,000 in exchange. They get a lump-sum and a successful settlement; you have one less debt to worry about and fewer monthly payments to meet.
Of course, creditors aren’t willing to forgive debts just because you offered. You can’t borrow $10,000 on a credit card, meet a few repayments, and then offer $5,000 to settle.
If it was that easy, no one would be in debt.
Debt settlement works for borrowers who have missed multiple payments and have either gone into collections or are close to doing so. At this point, lenders have lost their confidence that the debt will be repaid, and they will sell it to a collection agency for cents on the dollar, if they haven’t already done so.
By negotiating a settlement, you’re basically offering them a settlement sum that is larger than the amount they’d get from the collection agency. Of course, this means that debt settlement will only work if your credit score is low and your credit history is poor, or if you willingly take a hit to improve your chances of settling.
What is Debt Consolidation?
A consolidation loan is a little less aggressive than a debt settlement program, but it’ll also cost you more because debt consolidation works by increasing the total money that you pay while debt settlement reduces it.
The main goal of debt consolidation is to reduce your monthly payment, and it does this by consolidating all your debts (credit card debt, student loan debt, etc.,) into one personal loan. That loan may or may not have a smaller interest rate, but it always has a longer-term. This extended term is why debt consolidation companies are able to offer you such a reduced monthly payment.
Simply put, you may pay 50% less per month than your current debts, but you’ll be paying that amount for several more years. When you consolidate your debt in this manner, you’ll have an easier time managing things in the short-term but will pay much more over the long term.
Debt consolidation comes in several forms:
- Personal Loan: You can consolidate your debt yourself by taking out a personal loan. This will give you more control over the interest rate and term, but if you have a lot of debt and are struggling to meet payments, your credit score may have suffered, which will make it difficult to find a favorable loan.
- Balance Transfers: A balance transfer credit card allows you to move multiple credit card debts onto a single credit card, one that comes with a 0% introductory period of up to 18 months. You can use this period to repay your debt without worrying about escalating interest payments.
- Debt Management Plan: A debt management plan is offered to borrowers experiencing hardship. The debt management company will assume control of the individual’s debts, often insisting that they cancel all but one credit card before disturbing their monthly payment to all creditors.
- Consolidation Loan: A consolidation loan is provided by a company that specializes in consolidating debt and will arrange everything for you.
Why do you Need to Choose?
You don’t have to choose. If you have a high debt-to-income ratio then you can settle your debt on your own using debt payoff strategies and careful budgeting. Your credit score won’t drop, and you can steadily pay off student loans, credit card debt, and any other secured and unsecured debt you have.
However, if most of your income goes towards meeting monthly payments and covering high-interest rates, fees, and more, then it may help you to consolidate your debt, sign up for a debt management program or work with a debt settlement company.
Think about how much more money you’d have in your pocket if you didn’t need to cover those high-interest debt payments every month. You could spend more, save more, and worry less—that’s why it’s important to look into debt settlement and consolidation if you have demanding creditors on your back.
How to Choose Between the Two
If you have a lot of credit card debt and have already missed a few payments, or if you have several accounts in collections, debt settlement might be the best option. This is a hugely popular and closely regulated industry, one that is dominated by debt relief companies like National Debt Relief.
It’s one of the few true alternatives to bankruptcy and is also the cheapest way to clear your debts and wipe the slate clean. A consolidation loan is a little less aggressive and may be better suited if you have a decent credit score, no derogatory marks, and no desire to take any risks.
But before you decide, take a look at the benefits that both of these options provide.
What are the Advantages of Debt Settlement?
- Pay Less: If you have a credit card debt of $10,000 then you may pay up to $15,000 in total once the interest is added to the balance. With debt settlement, you could pay less than $5,000.
- Wipe the Slate Clean: Debt settlement will wipe your slate clean, clearing all your debts, bringing your monthly payments down to zero, and allowing you to start afresh.
- Free Consultation: If you work with a debt settlement company then you should receive a free consultation in the first instance. This will introduce you to the company and the service and help you to determine if it’s the right option for you. Some companies will pressure sell, but the best ones will try to help you and give you honest advice.
- You Can Do It Yourself: You don’t have to work with a debt specialist to settle your debts. If you have the time and a little knowledge, you can contact creditors yourself and negotiate settlements with them.
- Your Credit Score Doesn’t Matter: Your credit score won’t be factored into the equation here. In fact, in many cases, you may be better off with a low score, as that means your lenders are more likely to accept a settlement.
What are the Advantages of Debt Consolidation?
- Lower Payments: Your monthly payment may be reduced to less than 50% of its current total, providing a welcome relief if you have very little disposable income left over after you have cleared your debts and paid your bills.
- More Manageable: Turn multiple credit card debts and personal loans into a single, manageable debt. Not only does this make things easier, but it reduces the risk of fees, penalties, and other issues.
- Several Options: There are a few ways that you can initiate a debt consolidation loan, from a balance transfer credit card to a debt management program. These options will suit different types of debt.
- You Don’t Need Good Credit: Debt management programs are aimed at borrowers with poor credit, while many debt consolidation loans and balance transfers can help those with middling credit scores.
How Debt Settlement Affects Your Credit
Debt settlement programs often ask that you stop making payments. There are a couple of reasons for this. Firstly, as discussed already, more missed payments and derogatory marks mean your creditors are more likely to accept settlement offers. Secondly, by missing those monthly payments you can increase your disposable income and use all extra funds to pay the settlements.
This can do some serious damage to your FICO Score. What’s more, a settled debt is not as good as a fully paid debt and will have a negative effect on your credit score. It won’t be as damaging as bankruptcy, however, and if you already have those derogatory marks on your credit report then debt settlement won’t do much more damage.
How Debt Consolidation Affects Your Credit
A debt consolidation loan will place a hard inquiry on your credit report, and it will also be a new account, both of which will reduce your score. However, other loans and debts will be cleared, so your score should improve in time.
Things are a little different if you sign up for a debt management program. These programs are offered by credit unions and other nonprofits and they require you to close all your credit cards, keeping only one of them open to be used in emergencies. Closing all these accounts at once can greatly reduce your credit utilization ratio, which accounts for 30% of your total score.