Debt Consolidation vs. Debt Settlement

Debt Consolidation vs. Debt Settlement

Dealing with debt, especially significant amounts of debt, can be tough. Even if you haven’t fallen behind on payments, the idea of a mountain of debt that takes decades to pay off can seem exhausting. And if your financial situation is in disarray and you aren’t able to meet your debt obligations on a monthly basis, things can feel out of control.

The good news is you have options.

The challenge?

Understanding these options and knowing which one will be right for you.

Two of the most common ways to deal with debt involve consolidating it or paying it off. Both can provide some financial relief if you’re struggling to repay debt. And though each results in more flexibility with your financial situation each month, they are very different in how they are handled.

What is Debt Settlement?

Debt settlement occurs when you negotiate a pay-off amount for less than the total amount you owe and pay the credit card company in one lump sum. It’s often used when someone has an excessive amount of debt with a single creditor (though it’s possible to settle debts with more than one creditor).

For instance, let’s say you’ve accumulated $20,000 worth of debt on a credit card and the monthly minimum payment is far more than you can afford. The credit card company might be willing to negotiate an arrangement with you that allows you to “pay off” the total amount owed for pennies on the dollar. You pay them a one-time lump sum payment of $7000 to settle the debt.

What is Debt Consolidation?

On the other hand, debt consolidation is a method used to deal with multiple creditors. To consolidate debt, you’ll take out a single loan, pay off the various debts, and ideally, have a new large loan encompassing the others for a reasonable interest rate.

Handled properly, there are pros and cons to each method. Consolidation might be a good choice for those with several credit cards and other unsecured debts who are having trouble keeping up with all the payments due each month. Settlement is usually best for those who are dealing with a single large debt.

What are the Risks of Working with a Debt Settlement or Debt Consolidation Company?

Unfortunately, there are also many instances in which neither option is right, no matter how appealing they might seem initially. In many cases, consolidating debt does little to help you save money initially or in the long run. The same is true for settling your debt if you are unaware of the tax consequences or you hope to protect your credit score.

And if you work with a company that claims to offer consolidation or settlement assistance, when in reality they are scamming you out of your hard-earned money, neither option will help you immediately or in the long run.

You’ll end up with added cost from fees and penalties. One of the first things debt settlement companies do is tell you to stop paying your creditors and pay them instead. They promise to negotiate a settlement for you, but in the meantime, you’re racking up late fees, interest, and other penalties that are tacked on to what you already owe. And since the average time it takes to negotiate a debt settlement is two plus years, that’s a ton of late fees and penalties.

You’ll damage your credit score. Though this isn’t a concern to some – especially those who are deep in debt and already behind on payments – it is possible to have a lot of debt and still have a decent credit score if you’ve managed to keep up with payments to this point. Settling a debt negatively affects your score and following the advice of a debt settlement company that tells you to stop making payments on loans will really impact your score. Settling a debt also stays on your credit report for seven years, so future lenders will see you didn’t pay back all that you owed.

You’ll be paying the debt settlement company a fee for something you can do for free. Debt settlement companies don’t work free. As a matter of fact, their fees are often 20 to 25 percent of the final settlement, which can be several thousand dollars depending on how much you settle for. Wouldn’t you rather put that money toward paying off the debt itself?

The benefits of debt consolidation depend on the type of consolidation loan you use. There are plenty of great options out there that can save you money on a monthly basis and in the long run. Unfortunately, working with a company that claims to consolidate your debt for you can backfire and actually cost you more over time.

Understanding Your Options

It’s imperative, before deciding to consolidate your debt that you look closely at your options and not get tricked into working with a company that is trying to scam you. If an offer sees too good to be true or you’re encouraged to stop making payments on your debts before a loan is granted and you’ve received noticed a debt has been paid off, it’s best to move on. The last thing you want to do is damage your credit score just as you are about to see a boost from paying off debts with a consolidation loan.

In some cases, neither debt consolidation, nor debt settlement are going to be right for you. If you feel as though you’re struggling, but in reality things are just a little tighter than you’d like, it might be best to give it some time. On the other hand, if things truly are unmanageable and there’s no way you can afford to pay what you owe each month, a solution like bankruptcy might be your best option.

The best thing you can do is speak to a debt law firm who can help you make the right choice. He or she can also defend you against a lawsuit if a creditor should take legal action against you – something most debt settlement and debt consolidation companies cannot do.

For more information or to speak to someone about your financial challenges, contact us at 1.800.220.4318.

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