Debt Settlement And Debt Consolidation: What’s The Difference?
Have you ended up with a lot of monthly bills for high interest debt? If so, keeping track of all the payments you need to make can be a hassle – and you might even be unable to make all of those payments without running out of cash for basic living expenses.
If you are struggling with the debt you have, you may be considering different options to get your financial burden under control. You will likely come across two possible options for dealing with debt when trying to find a way to solve your problem: debt settlement and debt consolidation.
While debt consolidation and debt settlement may seem similar, there are major differences between the two processes. You need to understand both options – and the implications of each choice – before deciding whether one or the other is right for you.
What is debt consolidation?
Debt consolidation involves borrowing money to pay off existing debt. You take out a new loan and use the money from that new loan to pay off existing creditors.
You can consolidate your debt by taking out many types of new loans. For example, you could take out a personal loan and use the proceeds to consolidate your debt. You could take out a home equity loan and borrow against the equity in your home to pay off your existing debt. Or, you can apply for a balance transfer credit card and transfer the existing debts to the new card so that you have changed who you owe.
There are pros and cons to each of these different debt consolidation approaches, but what they all have in common is that your new loan has different repayment terms than existing debt.
Typically, when people consolidate their debt, they do so in order to lower the interest rate they are paying. If you are doing a balance transfer, for example, you may be able to get a 0% promotional rate, which will allow you to reduce your interest rate to 0%. Personal loans and home equity loans also typically have lower interest rates than most high-interest consumer debt, like credit cards.
Debt consolidation also allows you to have one payment – for your new loan – instead of multiple payments to existing creditors. This simplifies the repayment process and makes it much easier to repay what you owe.
Since your interest rate is lower, your new monthly payment may also be lower, depending on the length of the debt repayment period. The longer it takes to repay your new loan, the higher the total interest you will pay over time, but the lower your payment will be.
Debt consolidation doesn’t hurt your credit
Another thing that every consolidation loan has in common is that you pay off your existing debt in full. You are not reducing the total principal balance you need to pay off. While you may end up reducing the total amount you repay since you will be paying less interest, you still pay creditors the full amount you borrowed.
Because you pay off everything you’ve borrowed, debt consolidation doesn’t damage your credit. You may see a short-term drop in your credit score because a survey is sent to your credit report when you apply for the new loan, and a short-term drop if you max out a new credit card with your transferred balance.
But, as you pay off the consolidation loan and develop a positive payment history, your credit might actually improve. This is especially true if you’ve taken out a personal loan or home equity loan and now have a wider range of different types of credit on your credit report.
What Is Debt Settlement?
Debt settlement is very different from consolidation. It’s not about taking out a new loan to pay off what you owe. Instead, it’s about talking with existing creditors and coming to an agreement to pay less than you owe on your debt.
Creditors are usually unwilling to discuss debt settlement with you when you are up to date on your bills and at least making minimum payments. However, if you are late or if the creditors have reason to believe that you might default or file for bankruptcy, they may be willing to allow you to pay off your debt for less than you owe, because at least they will get paid. Something.
When you organize a debt settlement plan, you negotiate with creditors how much you will need to repay and the terms of repayment. There are debt settlement companies and credit counseling services that will do this for you, but many are unsavory, charge high fees, and don’t actually provide the help they promise. In most cases, you can be successful in speaking with creditors on your own as long as you have an idea of what you can afford and your proposal is reasonable.
When you negotiate a debt settlement plan, you can agree to pay a lump sum if the creditor cancels the remaining balance. Or, you can opt for a payment plan to pay a reduced amount, reducing your monthly payments and the total amount you owe.
Whatever you and your creditor agree to, make sure you get the plan in writing before sending any payment, and don’t give the creditor your bank account information.
With Debt Settlement, You Pay Less But Damage Your Credit
While every case is different, sometimes debt settlement can dramatically reduce the total amount you owe.
It is not uncommon for creditors to agree to a settlement that allows you to pay off only 30% to 70% of the outstanding balance if the creditor is very concerned that you may not be able to pay the bills. Being able to pay back less than what you’ve borrowed can be a huge plus if you’re in too much debt.
However, the problem is that debt settlement can be very damaging to your creditor. You will develop a history of late payments in the lead-up to debt settlement, otherwise creditors will not agree to negotiate with you. And, the debt will usually be reported as settled rather than paid in full, further damaging your credit.
Is debt settlement or consolidation right for you?
Debt consolidation can be a proactive step that helps you break free from debt and build your credit. Consolidating with a balance transfer credit card or personal loan has little or no risk, although consolidating with a home equity loan is a high risk choice. because you are putting your house in jeopardy if you cannot pay. If you have high interest debt and are eligible for a balance transfer or a personal loan that lowers your rate, there’s no reason not to.
Debt settlement, on the other hand, can hurt your credit for years to come. Debt settlement is always better than bankruptcy and, depending on the extent of your debt, it may be worth taking the blow to your credit to get out of a hole without having to spend years making payments that barely cover interest and reduce principal even less. .
Before you consider debt settlement, however, carefully consider whether you might be able to consolidate your debt into a new loan on better terms that you can repay more easily. If you think consolidation may be an option, do it as soon as possible before you have a history of late payments and no longer qualify for a new loan on more favorable terms.